[Federal Register Volume 88, Number 146 (Tuesday, August 1, 2023)]
[Notices]
[Pages 50205-50231]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2023-16267]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-98003; File No. SR-FINRA-2021-010]


Self-Regulatory Organizations; Financial Industry Regulatory 
Authority, Inc.; Order Setting Aside Action by Delegated Authority and 
Granting Approval of a Proposed Rule Change, as Modified by Amendment 
No. 1, To Amend the Requirements for Covered Agency Transactions Under 
FINRA Rule 4210 (Margin Requirements) as Approved Pursuant to SR-FINRA-
2015-036

July 27, 2023.

I. Introduction

A. Overview

1. Rulemaking by Self-Regulatory Organizations
    The Financial Industry Regulatory Authority, Inc. (``FINRA'') is 
registered with the Securities and Exchange Commission (``Commission'' 
or ``SEC'') as a national securities association under the Securities 
Exchange Act of 1934 (``Exchange Act'' or ``Act'').\1\ Under the 
Exchange Act, the rules of a national securities association for its 
broker-dealer members \2\ must, among other things, be designed to 
prevent fraudulent and manipulative acts and practices, to promote just 
and equitable principles of trade, to foster cooperation and 
coordination with persons engaged in regulating, clearing, settling, or 
processing information with respect to (and facilitating transactions 
in) securities, to remove impediments to and perfect the mechanism of a 
free and open market and a national market system, and, in general, to 
protect investors and the public interest.\3\ Further, under the 
Exchange Act, the rules of a national securities association must not 
impose any burden on competition not necessary or appropriate in 
furtherance of the purposes of the Act.\4\
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    \1\ See 15 U.S.C. 78o-3(a).
    \2\ See 15 U.S.C. 78c(a)(3)(B) (defining the term ``member'' 
when used with respect to a registered securities association to 
mean any broker or dealer who agrees to be regulated by such 
association and with respect to whom the association undertakes to 
enforce compliance with the Exchange Act, the rules and regulations 
thereunder, and its own rules).
    \3\ See 15 U.S.C. 78o-3(b)(6).
    \4\ See 15 U.S.C. 78o-3(b)(9).
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    FINRA, as a national securities association, also is a self-
regulatory organization (``SRO'') under the Exchange Act and its 
proposed rules are subject to Commission review and published for 
notice and comment.\5\ While certain types of proposed rules are 
effective upon filing, others are subject to Commission approval before 
they can go into effect.\6\ Under the Exchange Act, the Commission must 
approve an SRO's proposed rule if the Commission finds that the 
proposed rule change is consistent with the requirements of the Act and 
the applicable rules and regulations thereunder; if it does not make 
such a finding, the Commission must disapprove the proposed rule.\7\ 
The SRO has the burden to demonstrate that a proposed rule change is 
consistent with the Exchange Act and the rules and regulations issued 
thereunder.\8\
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    \5\ See 15 U.S.C. 78s(a) and (b).
    \6\ See 15 U.S.C. 78s(b).
    \7\ See 15 U.S.C. 78s(b)(2)(C).
    \8\ 17 CFR 201.700(b)(3).
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    The Exchange Act sets forth timeframes in which the Commission must 
either approve, disapprove, or institute proceedings to determine 
whether to approve or disapprove an SRO's proposed rule.\9\ If the 
Commission institutes proceedings, the Exchange Act sets forth 
timeframes in which the Commission must complete the proceedings and 
either approve or disapprove the SRO's proposed rule.\10\
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    \9\ See 15 U.S.C. 78s(b)(2).
    \10\ See 15 U.S.C. 78s(b)(2)(B).
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    The Commission has delegated authority to the staff of its Division 
of Trading and Markets (``Division'') to publish notice of an SRO's 
proposed rule for comment and to approve, disapprove, or institute 
proceedings to determine whether to approve or disapprove the proposed 
rule.\11\ Under the Commission's Rules of Practice, any person 
aggrieved by the Division's exercise of delegated authority may seek 
Commission review of the action by filing with the Commission: (1) a 
notice of intention to petition for review; and (2) a subsequent 
petition for review containing a clear and concise statement of the 
issues to be reviewed and the reasons why review is appropriate.\12\ 
The notice must be filed within fifteen days of the publication in the 
Federal Register of the action taken by the Division pursuant to 
delegated authority (e.g., publication of an order approving an SRO 
proposed rule) and the petition must be filed within five days after 
the filing of the notice.\13\ The Commission

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may grant or deny the petition for review.\14\ If the petition for 
review is granted, the Commission may affirm, reverse, modify, set 
aside, or remand for further proceedings, in whole or in part, the 
action made by the Division pursuant to delegated authority (e.g., the 
approval of an SRO proposed rule).\15\
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    \11\ See 17 CFR 200.30-3(a)(12) and (57).
    \12\ See 17 CFR 201.430(b)(1) and (2). The petition must include 
exceptions to any findings of fact or conclusions of law made, 
together with supporting reasons for such exceptions based on 
appropriate citations to such record as may exist. 17 CFR 
201.430(b)(2).
    \13\ See 17 CFR 201.430(b)(1) and (2).
    \14\ See 17 CFR 201.431(b).
    \15\ See 17 CFR 201.431(a).
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2. FINRA's Amendments to Rule 4210
    Most residential mortgages in the United States are securitized, 
with the underlying loans pooled into a separate legal trust, which 
issues mortgage-backed securities and passes on mortgage payments to 
investors after deducting mortgage servicing fees and other 
expenses.\16\ In the agency market, each mortgage-backed security 
carries a credit guarantee from Fannie Mae, Freddie Mac, or Ginnie 
Mae.\17\ Most agency mortgaged-backed security trading is conducted in 
the To-Be-Announced (``TBA'') market, with defined settlement dates for 
each month in the future.\18\ Most TBA transactions are nettable and 
clear through the Mortgage-Backed Securities Division of the Fixed 
Income Clearing Corporation (``MBSD'').\19\ Mortgage bankers may enter 
into a TBA transaction with a forward settlement date to hedge their 
mortgage pipeline.\20\ Agency mortgage-backed securities are debt 
instruments and may qualify as exempted securities under Section 
3(a)(12)(A) of the Exchange Act.\21\ Investors in the TBA market 
include, for example, banks, investment companies, investment funds, 
insurance companies, real estate investment trusts, and mortgage 
originators.\22\
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    \16\ See James Vickery & Joshua Wright, TBA Trading and 
Liquidity in the Agency MBS Market, Federal Reserve Bank of New 
York, Economic Policy Review (May 2013) at 2 (cited in Letter to 
Vanessa Countryman, Commission, from David H. Thompson. et al., at 
6-7 (Feb. 3, 2022) (``Petition for Review'')), available at https://www.sec.gov/rules/sro/finra/2022/34-94013-petn-cooper-kirk-020322.pdf).
    \17\ See Petition for Review at 7; U.S. Credit Markets: 
Interconnectedness and the Effects of the COVID-19 Economic Shock 
(Oct. 2020) at 62, available at https://www.sec.gov/files/US-Credit-Markets_COVID-19_Report.pdf (``DERA Report'') (cited in Exchange Act 
Release No. 91937 (May 19, 2021), 86 FR 28161, 28162, n.17 (May 25, 
2021) (``Notice'')).
    \18\ See Petition for Review at 9; DERA Report at 62; SIFMA TBA 
Market Fact Sheet (2015) at 2 (cited in Petition for Review at 9, 
n.10).
    \19\ See Petition for Review at 9.
    \20\ See Letter from Pete Mills, Senior Vice President, 
Residential Policy and Strategic Industry Engagement, Mortgage 
Bankers Association (May 10, 2022) (``MBA Letter'') at 1-2.
    \21\ 15 U.S.C. 78c(a)(12)(A). Exempted securities include U.S. 
Treasury securities or other securities which are direct obligations 
of, or obligations guaranteed as to principal or interest by, the 
United States or securities which are issued or guaranteed by 
corporations in which the United States has a direct or indirect 
interest (such as Fannie Mae and Freddie Mac).
    \22\ See DERA Report at 63.
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    Broker-dealers often require customers to post collateral or 
``margin'' to them in the form of cash or other securities in 
connection with the purchase and sale of securities. The requirement to 
post margin to a broker-dealer can be mandated by laws or regulations 
or agreed to by contract (provided the contract complies with minimum 
regulatory requirements). Broker-dealers may collect margin from 
customers for several purposes including, for the initial purchase of 
securities (``initial margin''), to maintain a minimum equity in the 
customer's account (``maintenance margin''), or to cover changes in the 
market value (or mark to market value) of the securities in the account 
(``variation margin''). In the securities markets, the Board of 
Governors of the Federal Reserve System (``Federal Reserve Board'') and 
SROs have set margin rules since the 1930s. The Federal Reserve Board 
generally sets initial margin requirements for broker-dealers in 
Regulation T.\23\ For example, Regulation T prescribes a 50% initial 
margin requirement for listed equity securities (meaning the customer 
must pay at least 50% of the market value of a listed equity security 
when purchasing it in a transaction financed by the broker-dealer). 
Regulation T also provides that the initial margin requirement for good 
faith securities--which includes exempted securities and non-equity 
securities (e.g., debt securities)--is the greater of the margin the 
broker-dealer requires in good faith or the amount an SRO requires.\24\ 
Agency securities (such as TBA securities) are good faith securities 
under Regulation T because they are debt securities, exempted 
securities, or both. SROs, such as FINRA, generally set maintenance 
margin requirements for their broker-dealer members. FINRA's primary 
margin rule for its broker-dealer members is FINRA Rule 4210 (Margin 
Requirements) (``Rule 4210''). For example, FINRA Rule 4210 prescribes 
a 25% maintenance margin requirement for listed equity securities 
(meaning the customer must maintain equity of at least 25% of the 
market value of the security). Consistent with the margin requirements 
for good faith securities under Regulation T, FINRA Rule 4210 also 
prescribes margin requirements for exempted securities (such as U.S. 
Treasury securities and agency securities), as well as transactions in 
exempted securities, mortgage related securities, or major foreign 
sovereign debt securities in an exempt account.\25\
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    \23\ See 12 CFR 220.1, et. seq.
    \24\ See 12 CFR 220.6(a)(2) and 220.12(b).
    \25\ See FINRA Rule 4210(e)(2)(A), (B) and (F). See also infra 
note 86 (defining ``exempt account'' under FINRA Rule 4210(a)(13)).
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    Prior to 2016, however, FINRA Rule 4210 did not specifically 
address the market for TBAs and other similar agency forward-settling 
transactions. In 2015, FINRA filed a proposed rule change under SR-
FINRA-2015-036 to amend FINRA Rule 4210 to establish requirements for: 
(1) TBA transactions,\26\ inclusive of adjustable rate mortgage 
(``ARM'') transactions; (2) Specified Pool Transactions; \27\ and (3) 
transactions in Collateralized Mortgage Obligations (``CMOs'') \28\ 
issued in conformity with a program of an agency \29\ or Government-
Sponsored Enterprise (``GSE''),\30\ with forward

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settlement dates (collectively, ``Covered Agency Transactions,'' also 
referred to, for purposes of this order, as the ``TBA market''). 
Broadly, the amendments required FINRA's broker-dealer members to: (1) 
perform credit risk determinations for counterparties with whom the 
broker-dealer engages in Covered Agency Transactions; and (2) collect 
margin from counterparties with respect to their Covered Agency 
Transactions with the broker-dealer.
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    \26\ See FINRA Rule 6710(u) defining TBA to mean a transaction 
in an Agency Pass-Through mortgage-backed security or a Small 
Business Administration (``SBA'')-Backed Asset-Backed Security 
(``ABS'') where the parties agree that the seller will deliver to 
the buyer a pool or pools of mortgages of a specified face amount 
and meeting certain other criteria but the specific pool or pools to 
be delivered at settlement is not specified at the Time of 
Execution, and includes TBA transactions for good delivery and TBA 
transactions not for good delivery.
    \27\ See FINRA Rule 6710(x) defining Specified Pool Transaction 
to mean a transaction in an Agency Pass-Through mortgage-backed 
security or an SBA-Backed ABS requiring the delivery at settlement 
of a pool or pools that is identified by a unique pool 
identification number at the Time of Execution.
    \28\ See FINRA Rule 6710(dd) defining ``CMO'' to mean a type of 
Securitized Product backed by Agency Pass-Through mortgage-backed 
securities, mortgage loans, certificates backed by project loans or 
construction loans, other types of mortgage-backed securities or 
assets derivative of mortgage-backed securities, structured in 
multiple classes or tranches with each class or tranche entitled to 
receive distributions of principal or interest according to the 
requirements adopted for the specific class or tranche, and includes 
a real estate mortgage investment conduit (``REMIC'').
    \29\ See FINRA Rule 6710(k) defining ``agency'' to mean a United 
States executive agency as defined in 5 U.S.C. 105 that is 
authorized to issue debt directly or through a related entity, such 
as a government corporation, or to guarantee the repayment of 
principal or interest of a debt security issued by another entity. 
The term excludes the U.S. Department of the Treasury in the 
exercise of its authority to issue U.S. Treasury Securities as 
defined under FINRA Rule 6710(p). Under 5 U.S.C. 105, the term 
``executive agency'' is defined to mean an ``Executive department, a 
Government corporation, and an independent establishment.''
    \30\ See FINRA Rule 6710(n) defining ``GSE'' to have the meaning 
set forth in 2 U.S.C. 622(8). Under 2 U.S.C. 622(8), a GSE is 
defined, in part, to mean a corporate entity created by a law of the 
United States that has a Federal charter authorized by law, is 
privately owned, is under the direction of a board of directors, a 
majority of which is elected by private owners, and, among other 
things, is a financial institution with power to make loans or loan 
guarantees for limited purposes such as to provide credit for 
specific borrowers or one sector and raise funds by borrowing (which 
does not carry the full faith and credit of the Federal Government) 
or to guarantee the debt of others in unlimited amounts.
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    As discussed below, FINRA's initial amendments to Rule 4210 
regarding Covered Agency Transactions went through a notice and comment 
period during which FINRA filed three amendments to the proposed rule 
change that, among other things, responded to comments about the 
potential burdens of the proposed rule change, including the potential 
burdens on smaller broker-dealers.\31\ In June 2016, the Division, 
pursuant to delegated authority, approved FINRA's amendments to Rule 
4210 (``2016 Amendments'').\32\ No petition was filed with the 
Commission to review the staff's exercise of delegated authority to 
approve the 2016 Amendments.
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    \31\ See section I.B.1. of this order (discussing the procedural 
history of the notice and comment period for the 2016 Amendments).
    \32\ Exchange Act Release No. 78081 (June 15, 2016), 81 FR 
40364, 40375 (June 21, 2016) (Notice of Filing of Amendment No. 3 
and Order Granting Accelerated Approval to a Proposed Rule Change to 
Amend FINRA Rule 4210 (Margin Requirements) to Establish Margin 
Requirements for the TBA Market, as Modified by Amendment Nos. 1, 2, 
and 3; File No. SR-FINRA-2015-036) (``2016 Approval Order'').
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    Under the 2016 Amendments, FINRA's broker-dealer members must make 
and enforce a written risk limit determination for each counterparty 
with whom the broker-dealer engages in Covered Agency Transactions.\33\ 
The effective date for the credit risk determination requirement was 
December 15, 2016 and, therefore, FINRA's broker-dealer members 
currently are subject to this requirement. Further, under the 2016 
Amendments, FINRA's broker-dealer members (unless an exception applies) 
must collect the daily mark to market loss from all counterparties with 
respect to their Covered Agency Transactions and for non-exempt 
accounts also collect maintenance margin of two percent.\34\ The 
effective date for these margin collection requirements is October 25, 
2023.\35\
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    \33\ See Rule 4210(e)(2)(H)(ii)(b).
    \34\ See Rule 4210(e)(2)(H)(i) and (ii) under the 2016 
Amendments. Under the 2016 Amendments, the daily mark to market loss 
is a counterparty's loss (i.e., the broker-dealer's gain) resulting 
from marking a Covered Agency Transaction to the market. See Rule 
4210(e)(2)(H)(i)g. The maintenance margin amount is two percent of 
the contract value of the net ``long'' or net ``short'' position in 
Covered Agency Transactions, by CUSIP, with the counterparty. See 
Rule 4210(e)(2)(H)(i)f. An exempt account is an account of another 
broker-dealer or a person with a net worth of at least $45 million 
and financial assets of at least $40 million and who meets one of 
five other conditions. See Rule 4210(a)(13). See also infra note 86 
(defining ``exempt account'' under FINRA Rule 4210(a)(13)).
    \35\ See Exchange Act Release No. 97062 (Mar. 7, 2023), 88 FR 
15473 (Mar. 13, 2023) (File No. SR-FINRA-2023-002).
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    With respect to the 2016 Amendments, FINRA stated it would consider 
amending them as may be necessary to mitigate their impact on smaller 
broker-dealers.\36\ Interested parties told FINRA that the 2016 
Amendments favor larger broker-dealers because they have more market 
power to negotiate margin agreements or Master Securities Forward 
Transactions Agreements (``MSFTAs'') with their counterparties, and 
that smaller broker-dealers also are at a competitive disadvantage to 
non-FINRA members (i.e., regional banks) because these entities are not 
subject to margin requirements for Covered Agency Transactions. 
Additionally, some smaller broker-dealers told FINRA that, among other 
things, the ability to take a capital charge in lieu of collecting 
margin would help alleviate this competitive disadvantage, though it 
would not fully resolve the competitive disparity between FINRA's 
broker-dealer members subject to FINRA Rule 4210 and regional banks 
that are not subject to similar margin requirements.\37\
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    \36\ See 2016 Approval Order, 81 FR at 40375.
    \37\ See Notice, 86 FR at 28162.
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    To address these concerns, FINRA filed a proposed rule change in 
2021 (SR-FINRA-2021-010) to amend the margin collection requirements 
for Covered Agency Transactions in Rule 4210 that were adopted under 
the 2016 Amendments. As discussed below, FINRA's proposed amendments 
went through a notice and comment period during which FINRA filed one 
amendment that, among other things, responded to comments about the 
potential burdens of the proposal.\38\ Generally, as discussed below, 
the proposed amendments are intended to further reduce the burdens of 
the margin collection requirements with respect to Covered Agency 
Transactions, particularly for smaller broker-dealers. In January 2022, 
the Division, pursuant to delegated authority, approved these 
amendments (``2021 Amendments'').\39\
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    \38\ See section I.B.2. of this order (discussing the procedural 
history of the 2021 Amendments).
    \39\ See Exchange Act Release No. 94013 (Jan. 20, 2022), 87 FR 
4076 (Jan. 26, 2022) (SR-FINRA-2021-010) (``2022 Approval Order'').
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    As discussed below, the 2021 Amendments would (among other things): 
(1) eliminate the two percent maintenance margin requirement that 
applies to non-exempt accounts; (2) permit broker-dealers to take a 
capital charge in lieu of collecting the mark to market loss, subject 
to specified conditions and limitations; and (3) make revisions 
designed to streamline, consolidate, and clarify the text of the rule. 
The 2021 Amendments also include an implementation schedule for the 
requirements in Rule 4210 pertaining to collecting margin with respect 
to Covered Agency Transactions, as those requirements would be amended 
by the 2021 Amendments (``Amended Margin Collection Requirements''). 
The implementation schedule provides that FINRA would announce the 
effective date for the Amended Margin Collection Requirements no later 
than 60 days following the Commission's approval of the 2021 Amendments 
and the announced effective date would be between nine and ten months 
following the approval.
    In February 2022, the Bond Dealers of America (``BDA'') and Brean 
Capital, LLC (``Brean Capital'') (collectively, the ``Petitioners'') 
jointly filed a timely petition requesting that the Commission review 
the Division's approval of the 2021 Amendments.\40\ The Commission 
granted the Petition for Review and, thereby, agreed to review the 
Division's action under delegated authority.\41\
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    \40\ See Petition for Review. Prior to the filing of the 
Petition for Review, the Petitioners timely filed a notice of their 
intent to file a petition.
    \41\ See Exchange Act Release No. 94724 (Apr. 14, 2022), 87 FR 
23287 (Apr. 19, 2022) (``2022 Scheduling Order'').
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    The Petitioners requested that the Commission disapprove the 2021 
Amendments. Procedurally, if the Commission disapproves the 2021 
Amendments, the 2016 Amendments would remain in place and become 
effective on October 25, 2023. Among other things, this would mean that 
the Amended Margin Collection Requirements--which would reduce certain 
burdens of the 2016 Amendments--would not take effect.
    In response to the Petition for Review, the Commission has 
conducted a de novo review of the Division's action by delegated 
authority approving the 2021 Amendments. The review gave careful 
consideration to the entire record--including FINRA's filings, the

[[Page 50208]]

comments and statements received on the filings, FINRA's responses to 
those comments and statements, the Petition for Review, and the 
comments and statements received in response to the Petition for 
Review--to determine whether the 2021 Amendments are consistent with 
the requirements of the Exchange Act and the rules and regulations 
thereunder, including that they do not impose any burden on competition 
not necessary or appropriate in furtherance of the purposes of the 
Exchange Act.\42\
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    \42\ See 15 U.S.C. 78o-3(b)(6) and (9).
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    For the reasons discussed below, the Commission finds that FINRA 
has met its burden to show that the 2021 Amendments are consistent with 
the requirements of the Exchange Act and the applicable rules and 
regulations thereunder; including that they do not impose any burden on 
competition not necessary or appropriate in furtherance of the purposes 
of the Act.\43\ Consequently, the Commission is: (1) setting aside the 
Division's 2022 Approval Order approving the 2021 Amendments pursuant 
to delegated authority; and (2) approving the 2021 Amendments.
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    \43\ See 15 U.S.C. 78o-3(b)(6) and (9).
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    Finally, as discussed below, the 2021 Amendments were subject to 
notice and comment which provided multiple opportunities for interested 
parties to comment. The proposed rule change also included the 
institution of proceedings, which afforded interested parties 
additional opportunities and time to provide comments to the 
Commission. Consequently, the record for the 2021 Amendments includes 
numerous comments, and responses from FINRA to the comments.\44\
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    \44\ See section I.B.2. of this order (discussing the procedural 
history of the 2021 Amendments).
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B. Procedural History and Background of Covered Agency Transaction 
Margin Requirements

1. The 2016 Amendments (SR-FINRA-2015-036)
    On October 6, 2015, FINRA filed with the Commission, pursuant to 
Section 19(b)(1) of the Exchange Act \45\ and Rule 19b-4 
thereunder,\46\ a proposed rule change to amend FINRA Rule 4210 to 
establish margin requirements for Covered Agency Transactions (i.e., 
the requirements that FINRA's broker-dealer members perform credit risk 
determinations and collect margin with respect to Covered Agency 
Transactions).\47\ The proposed rule change was published for comment 
in the Federal Register on October 20, 2015.\48\ On November 10, 2015, 
FINRA extended the time period in which the Commission must approve the 
proposed rule change, disapprove the proposed rule change, or institute 
proceedings to determine whether to approve or disapprove the proposed 
rule change to January 15, 2016.\49\ The Commission received over 100 
comment letters on the proposed amendments.\50\
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    \45\ 15 U.S.C. 78s(b)(1).
    \46\ 17 CFR 240.19b-4.
    \47\ See File No. SR-FINRA-2015-036. Certain documents related 
to this rule change are available on FINRA's website at: https://www.finra.org/rules-guidance/rule-filings/sr-finra-2015-036.
    \48\ See Exchange Act Release No. 76148 (Oct. 14, 2015), 80 FR 
63603 (Oct. 20, 2015) (File No. SR-FINRA-2015-036).
    \49\ See Letter to Katherine England, Assistant Director, 
Division, Commission from Adam Arkel. Associate General Counsel, 
Office of the General Counsel, FINRA (Nov. 10, 2015).
    \50\ The public comment file for the proposed rule change is 
available at: https://www.sec.gov/comments/sr-finra-2015-036/finra2015036.shtml (``2016 Rulemaking Comment File''). The 
Commission staff also participated in numerous meetings and 
conference calls with certain commenters and other market 
participants, which are also noted in the 2016 Rulemaking Comment 
File.
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    On January 13, 2016, FINRA responded to the comments and filed 
Amendment No. 1 to the proposed rule change.\51\ In response to 
comments, Amendment No. 1, among other things, excluded certain types 
of securities from the scope of the proposed margin requirements and 
set bifurcated implementation dates for when broker-dealers would need 
to begin complying with the amendments if the Commission approved them: 
six months with respect to the credit risk determination requirements 
and eighteen months with respect to the margin collection requirements.
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    \51\ See Amendment No. 1 to the proposed rule change (Jan. 13, 
2016) (``Amendment No. 1'').
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    On January 14, 2016, the Commission issued an order instituting 
proceedings pursuant to Section 19(b)(2)(B) of the Exchange Act \52\ to 
determine whether to approve or disapprove the proposed rule change, as 
modified by Amendment No. 1.\53\ The 2016 Order Instituting Proceedings 
was issued by the Division pursuant to delegated authority and was 
published in the Federal Register on January 21, 2016.\54\ By 
instituting proceedings, the Commission extended by 90 days the date by 
which the Commission would need to approve or disapprove the proposed 
amendments and provided the opportunity for further extensions. The 
Commission received more than 20 comment letters in response to the 
2016 Order Instituting Proceedings.\55\ On March 21, 2016, FINRA 
responded to the comments and filed Amendment No. 2.\56\ The amendment, 
among other things, clarified certain text of the proposed rule.
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    \52\ 15 U.S.C. 78s(b)(2)(B).
    \53\ See Exchange Act Release No. 76908 (Jan. 14, 2016), 81 FR 
3532 (Jan. 21, 2016) (Order Instituting Proceedings To Determine 
Whether To Approve or Disapprove Proposed Rule Change to Amend FINRA 
Rule 4210 (Margin Requirements) to Establish Margin Requirements for 
the TBA Market, as Modified by Partial Amendment No. 1) (``2016 
Order Instituting Proceedings'').
    \54\ Id.
    \55\ See 2016 Rulemaking Comment File.
    \56\ See Amendment No. 2 to the proposed rule change (Mar. 21, 
2016) (``Amendment No. 2'').
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    On April 15, 2016, notice of Amendment No. 2 to the proposed rule 
change was published in the Federal Register to solicit comments from 
interested persons and to designate a longer period for Commission 
action on the proposed rule change: until June 16, 2016.\57\ The 
Commission received nine additional comment letters in response to the 
Amendment No. 2 Notice.\58\ On May 26, 2016, FINRA responded to the 
comments and filed Amendment No. 3.\59\ Amendment No. 3 expanded the 
applicability of an exception under which the broker-dealer would not 
need to collect margin from counterparties with limited Covered Agency 
Transactions. In particular, the amendment applied the exception to 
counterparties with $10 million or less in gross open Covered Agency 
Transactions instead of a lower threshold of $2.5 million or less, as 
originally proposed.
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    \57\ See Exchange Act Release No. 77579 (Apr. 11, 2016), 81 FR 
22347 (Apr. 15, 2016) (Notice of Filing of Amendment No. 2 and 
Designation of a Longer Period for Commission Action on Proceedings 
to Determine Whether to Approve or Disapprove Proposed Rule Change 
to Amend FINRA Rule 4210 (Margin Requirements) to Establish Margin 
Requirements for the TBA Market, as Modified by Amendment Nos. 1 and 
2) (``Amendment No. 2 Notice'').
    \58\ See 2016 Rulemaking Comment File.
    \59\ See Amendment No. 3 to the proposed rule change (May 26, 
2016) (``Amendment No. 3'').
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    On June 21, 2016, a notice and order was published in the Federal 
Register to solicit comment on Amendment No. 3 and approve the proposed 
rule change, as modified by Amendment Nos. 1, 2, and 3 on an 
accelerated basis (i.e., approve the 2016 Amendments).\60\ The Division 
issued the 2016 Approval Order pursuant to delegated authority. The 
Commission did not receive any comments in response to the notice of 
Amendment No. 3. Further, no petition was filed with the Commission to 
review the Division's action approving the 2016 Amendments by delegated 
authority. The effective date for the

[[Page 50209]]

requirement to perform credit risk determinations under the 2016 
Amendments was December 15, 2016. The effective date for the margin 
collection requirements for Covered Agency Transactions under the 2016 
Amendments is October 25, 2023.\61\
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    \60\ 2016 Approval Order.
    \61\ See Exchange Act Release No. 97062 (Mar. 7, 2023), 88 FR 
15473 (Mar. 13, 2023) (File No. SR-FINRA-2023-002) (extending the 
implementation date of the margin collection requirements under SR-
FINRA-2015-036 from April 24, 2023 to October 25, 2023).
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2. The 2021 Amendments (SR-FINRA-2021-010)
    On May 7, 2021, FINRA filed with the Commission, pursuant to 
Section 19(b)(1) of the Exchange Act \62\ and Rule 19b-4 
thereunder,\63\ a proposed rule change to amend the margin requirements 
for Covered Agency Transactions under Rule 4210.\64\ The proposed rule 
change would: (1) eliminate the two percent maintenance margin 
requirement that applies to non-exempt accounts; (2) subject to 
specified conditions and limitations, permit members to take a capital 
charge in lieu of collecting margin for excess net mark to market 
losses on Covered Agency Transactions; and (3) make revisions designed 
to streamline, consolidate and clarify the Covered Agency Transaction 
rule language. The proposed rule change was published for comment in 
the Federal Register on May 25, 2021.\65\ On June 30, 2021, FINRA 
extended the time period in which the Commission must approve the 
proposed rule change, disapprove the proposed rule change, or institute 
proceedings to determine whether to approve or disapprove the proposed 
rule change to August 23, 2021.\66\ The Commission received five 
comment letters in response to the proposed rule change.\67\
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    \62\ 15 U.S.C. 78s(b)(1).
    \63\ 17 CFR 240.19b-4.
    \64\ The full text of the proposed rule change and the exhibits 
FINRA filed are collectively referred to as the ``proposal,'' and 
are available at: https://www.finra.org/rules-guidance/rule-filings/sr-finra-2021-010.
    \65\ See Notice.
    \66\ See Letter from Adam Arkel, Associate General Counsel, 
Office of General Counsel, FINRA, to Sheila Swartz, Division, 
Commission (June 30, 2021).
    \67\ The public comment file for the proposed rule change is 
published on the Commission's website at: https://www.sec.gov/comments/sr-finra-2021-010/srfinra2021010.htm (``2021 Rulemaking 
Comment File'').
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    On August 9, 2021, FINRA responded to the comments and filed 
Amendment No. 1 (2021) to the proposed rule change.\68\ In response to 
comments, Amendment No. 1 (2021), among other things, would: (1) modify 
the definition of ``non-margin counterparty'' to exclude small cash 
counterparties and other exempted counterparties; (2) define a FINRA 
member's ``specified net capital deductions'' as the net capital 
deductions required by paragraph (e)(2)(H)(ii)d.1. of FINRA Rule 4210 
with respect to all unmargined excess net mark to market losses of its 
counterparties, except to the extent that the member, in good faith, 
expects such excess net mark to market losses to be margined by the 
close of business on the fifth business day after they arose; and (3) 
set an implementation date for the Amended Margin Collection 
Requirements.\69\
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    \68\ See Amendment No. 1 to the proposed rule change (Aug. 9, 
2021) (``Amendment No. 1 (2021)'').
    \69\ See Amendment No. 1 (2021).
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    On August 20, 2021, the Commission issued an order instituting 
proceedings pursuant to Section 19(b)(2)(B) of the Exchange Act \70\ to 
determine whether to approve or disapprove the proposed rule change, as 
modified by Amendment No. 1 (2021).\71\ The 2021 Order Instituting 
Proceedings was issued by the Division pursuant to delegated authority 
and was published in the Federal Register on August 26, 2021.\72\ The 
Commission received two comment letters in response to the 2021 Order 
Instituting Proceedings.\73\ On September 16, 2021, FINRA responded to 
the comments received in response to the 2021 Order Instituting 
Proceedings.\74\ On October 26, 2021, FINRA extended the time period in 
which the Commission must approve or disapprove the proposed rule 
change to January 20, 2022.\75\
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    \70\ 15 U.S.C. 78s(b)(2)(B).
    \71\ See Exchange Act Release No. 92713 (Aug. 20, 2021), 86 FR 
47655 (Aug. 26, 2021) (``2021 Order Instituting Proceedings'').
    \72\ Id.
    \73\ See 2021 Rulemaking Comment File.
    \74\ See Letter from Adam Arkel, Associate General Counsel, 
Office of General Counsel, FINRA, to Vanessa Countryman, Commission 
(Sept. 16, 2021) (``FINRA Letter'').
    \75\ See Letter from Adam Arkel, Associate General Counsel, 
Office of General Counsel, FINRA, to Sheila Swartz, Division, 
Commission (Oct. 26, 2021).
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    On January 20, 2022, the Division, acting pursuant to delegated 
authority on behalf of the Commission,\76\ approved the proposed rule 
change, as modified by Amendment No. 1 (2021).\77\ On January 27, 2022, 
the BDA and Brean Capital--the ``Petitioners''--filed a notice of 
intention to petition for review of the 2022 Approval Order.\78\ 
Pursuant to the Commission's Rules of Practice 431(e), the 2022 
Approval Order was stayed by the filing with the Commission of a notice 
of intention to petition for review.\79\ On February 3, 2022, the 
Petitioners jointly filed a timely Petition for Review.\80\ On April 
14, 2022, the Commission issued a scheduling order, pursuant to 
Commission's Rules of Practice, granting the Petition for Review of the 
2022 Approval Order and providing until May 10, 2022 for any party or 
other person to file a written statement in support of, or in 
opposition to, the 2022 Approval Order.\81\ The scheduling order also 
stated that the proposed rule change, as modified by Amendment No. 1 
(2021), shall remain stayed pending further Commission action.\82\ On 
May 10, 2022, FINRA submitted a written statement in support of the 
2022 Approval Order.\83\ On May 10, 2022, the Petitioners submitted a 
written statement in opposition to the 2022 Approval Order.\84\ The 
Commission also received over ten additional statements from market 
participants in response to the Petition for Review.\85\
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    \76\ 17 CFR 200.30-3(a)(12).
    \77\ See 2022 Approval Order.
    \78\ See Notice of Intention to Petition for Review of Order 
Granting Approval of a Proposed Rule Change, as Modified by 
Amendment No. 1, to Amend the Requirements for Covered Agency 
Transactions Under FINRA Rule 4210 (Margin Requirements) as Approved 
Pursuant to SR-FINRA-2015-036, Release No. 34-94013; File No. SR-
FINRA-2021-010, available at https://www.sec.gov/rules/sro/finra/2022/34-94013-petn-cooper-kirk.pdf.
    \79\ 17 CFR 201.431(e).
    \80\ See Petition for Review.
    \81\ See 2022 Scheduling Order.
    \82\ Id.
    \83\ See FINRA's Statement in Support of Proposed Rule Change to 
Amend the Requirements for Covered Agency Transactions Under FINRA 
Rule 4210 (File No. SR-FINRA-2021-010) (``FINRA Statement'').
    \84\ See Petitioners' Statement in Opposition to Approval of the 
Proposed Rule Change (``Petitioners' Statement'').
    \85\ See 2021 Rulemaking Comment File. Weichert Financial 
Services submitted six nearly identical letters signed by different 
individuals. See Letters from Nancy Crocetto, SVP, Mortgage 
Operations (May 9, 2022); Eric Declercq, President (May 9, 2022); 
James M. Weichert, President & Chief Executive Officer (May 9, 
2022); Anthony P. Fattizzi, Chief Risk Officer (May 4, 2022); 
Michael Cadematori (May 4, 2022); Timothy McLaughlin, Chief 
Investment Officer (May 3, 2022). These are collectively considered 
one comment letter and referred to as the ``Weichert Letters.''
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II. How the 2021 Amendments Would Change the Covered Agency Transaction 
Margin Requirements of Rule 4210

A. Elimination of the Two Percent Maintenance Margin Requirement

    Under the 2016 Amendments, Rule 4210 imposes different margin 
requirements for accounts that are ``exempt accounts'' and accounts 
that are not ``exempt accounts.'' Accounts that are not ``exempt 
accounts'' under the 2016 Amendments are subject to stricter margin 
requirements than

[[Page 50210]]

``exempt accounts'' because the broker-dealer is required to collect 
two percent maintenance margin with respect to these accounts in 
addition to margin to cover the counterparty's mark to market loss.\86\ 
In particular, paragraph (e)(2)(H)(ii)e. of Rule 4210 broadly provides 
that the broker-dealer must collect margin from counterparties that are 
non-exempt accounts equal to the maintenance margin amount, defined to 
mean margin equal to two percent of the contract value of the net long 
or net short position, by CUSIP, with the counterparty, plus any net 
mark to market loss, subject to specified exceptions under the 
rule.\87\ By contrast, under the 2016 Amendments, paragraph 
(e)(2)(H)(ii)d. of Rule 4210 broadly provides that the broker-dealer 
must collect margin from counterparties that are exempt accounts equal 
to any net mark to market loss, subject to specified exceptions under 
the rule (i.e., maintenance margin need not be collected).\88\
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    \86\ The term ``exempt account'' is defined under FINRA Rule 
4210(a)(13). Broadly, an exempt account means a FINRA member, a non-
FINRA member registered broker-dealer, an account that is a 
``designated account'' under FINRA Rule 4210(a)(4) (specifically, a 
bank as defined under Section 3(a)(6) of the Exchange Act, a savings 
association as defined under Section 3(b) of the Federal Deposit 
Insurance Act, the deposits of which are insured by the Federal 
Deposit Insurance Corporation, an insurance company as defined under 
Section 2(a)(17) of the Investment Company Act, an investment 
company registered with the Commission under the Investment Company 
Act, a state or political subdivision thereof, or a pension plan or 
profit sharing plan subject to the Employee Retirement Income 
Security Act or of an agency of the United States or of a state or 
political subdivision thereof), and any person that has a net worth 
of at least $45 million and financial assets of at least $40 million 
for purposes of paragraphs (e)(2)(F), (e)(2)(G) and (e)(2)(H) of 
FINRA Rule 4210, as set forth under paragraph (a)(13)(B)(i) of FINRA 
Rule 4210, and meets specified conditions as set forth under 
paragraph (a)(13)(B)(ii). See Notice, 86 FR at 28163, n.18. Unless 
otherwise noted, references to the 2016 Amendments are to the 
``current rule'' or ``original rulemaking.''
    \87\ See 2016 Approval Order, 81 FR at 40367; see also paragraph 
(e)(2)(H)(ii)e. of the current rule in Exhibit 5. The rule further 
sets forth specified requirements for net capital deductions and the 
liquidation of positions in the event the uncollected maintenance 
margin and mark to market loss (defined together under paragraph 
(e)(2)(H)(i)d. of the current rule as the ``deficiency'') is not 
satisfied. In short, the rule provides that if the deficiency is not 
satisfied by the close of business on the next business day after 
the business day on which the deficiency arises, the member shall be 
required to deduct the amount of the deficiency from net capital as 
provided in Exchange Act Rule 15c3-1 until such time the deficiency 
is satisfied; under the rule, if such deficiency is not satisfied 
within five business days from the date the deficiency was created, 
the member must promptly liquidate positions to satisfy the 
deficiency, unless FINRA has specifically granted the member 
additional time. As discussed in further detail below, the proposed 
rule change would eliminate current paragraph (e)(2)(H)(ii)e. in its 
entirety.
    \88\ See 2016 Approval Order, 81 FR at 40367; see also paragraph 
(e)(2)(H)(ii)d. of the current rule in Exhibit 5 to the 2016 
Amendments. Similar to paragraph (e)(2)(H)(ii)e., current paragraph 
(e)(2)(H)(ii)d. provides that if the mark to market loss is not 
satisfied by the close of business on the next business day after 
the business day on which the mark to market loss arises, the member 
is required to deduct the amount of the mark to market loss from net 
capital as provided in Exchange Act Rule 15c3-1 until such time the 
mark to market loss is satisfied; if such mark to market loss is not 
satisfied within five business days from the date the loss was 
created, the member must promptly liquidate positions to satisfy the 
mark to market loss, unless FINRA has specifically granted the 
member additional time. Again, as discussed in further detail below, 
the proposed rule change would eliminate current paragraph 
(e)(2)(H)(ii)d. in its entirety.
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    In connection with the 2021 Amendments, FINRA stated that broker-
dealer members expressed concern that the different treatment of exempt 
and non-exempt accounts is burdensome because members will be obligated 
to obtain and assess the financial information needed to determine 
which counterparties must be treated as non-exempt accounts.\89\ 
Further, based on feedback from members since the approval date of the 
2016 Amendments and additional observation of market conditions, FINRA 
stated it now believes that the potential risk that the maintenance 
margin requirement was intended to address when originally proposed is 
not significant enough to warrant the burdens and competitive 
disadvantage that the requirement imposes.\90\ According to FINRA, 
members pointed out that, in practice, the maintenance margin 
requirement would apply to relatively few accounts of entities that 
participate in the Covered Agency Transaction market. Further, FINRA 
stated that monitoring and collecting maintenance margin for these 
accounts will be operationally burdensome and out of proportion with 
the number and size of the affected accounts.\91\ Further, according to 
FINRA, bank dealers are not subject to the requirement to collect 
maintenance margin from their customers, which would significantly 
disadvantage broker-dealers that compete with bank dealers.\92\ To 
address these concerns, FINRA proposed to eliminate paragraphs 
(e)(2)(H)(ii)d. and (e)(2)(H)(ii)e. of Rule 4210, and replace them with 
new paragraph (e)(2)(H)(ii)c. This paragraph would provide that FINRA's 
broker-dealer members must collect margin for each counterparty's \93\ 
excess net mark to market loss,\94\ unless

[[Page 50211]]

otherwise provided under proposed new paragraph (e)(2)(H)(ii)d. of the 
rule, as discussed further below. As such, both exempt and non-exempt 
accounts would receive the same margin treatment for purposes of 
Covered Agency Transactions under paragraph (e)(2)(H).\95\ In 
particular, under the amendments, FINRA's broker-dealer members would 
not be required to collect the two percent maintenance margin amount 
for non-exempt accounts.
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    \89\ See Notice, 86 FR at 28163. Further, FINRA stated that 
members expressed concern that some asset manager counterparties 
face constraints with regard to custody of assets at broker-dealers 
and that, because of these constraints, some members need to enter 
into separate custodial agreements with third party banks to hold 
the maintenance margin that they collect from these asset managers. 
Members expressed concern that this imposes operational burdens both 
on themselves and their client counterparties, who may, as a 
consequence, choose to limit their dealings with smaller broker-
dealers. Id. at n.23.
    \90\ See Notice, 86 FR at 28163.
    \91\ Id.
    \92\ Id.
    \93\ Current paragraph (e)(2)(H)(i)b. defines the term 
``counterparty'' to mean any person that enters into a Covered 
Agency Transaction with a member and includes a ``customer'' as 
defined in paragraph (a)(3) under FINRA Rule 4210. The proposed rule 
change would redesignate the definition of counterparty as paragraph 
(e)(2)(H)(i)a. under the rule and revise the definition to provide 
that the term ``counterparty'' means any person, including any 
``customer'' as defined in paragraph (a)(3) of the rule, that is a 
party to a Covered Agency Transaction with, or guaranteed by, a 
member. FINRA believes that including transactions guaranteed by a 
member is a useful clarifying change in the context of Covered 
Agency Transactions. In connection with this change, FINRA proposes 
to add new Supplemental Material .02, which would provide that, for 
purposes of paragraph (e)(2)(H), a member is deemed to have 
``guaranteed'' a transaction if the member has become liable for the 
performance of either party's obligations under the transaction. See 
proposed new Supplemental Material .02 in Exhibit 5 to the proposal. 
Accordingly, if a clearing broker were to guarantee to an introduced 
customer an introducing broker's obligations under a Covered Agency 
Transaction between that introducing firm and customer, the 
introducing broker would be considered a ``counterparty'' of the 
clearing broker for purposes of paragraph (e)(2)(H). See also 
Notice, 86 FR at 28163-64, n.25.
    \94\ FINRA proposes to delete the current definition of ``mark 
to market loss'' under paragraph (e)(2)(H)(i)g. as adopted pursuant 
to the 2016 Approval Order and to replace it with a definition of 
``net mark to market loss'' under proposed new paragraph 
(e)(2)(H)(i)d. Under the new definition, a counterparty's ``net mark 
to market loss'' would mean (1) the sum of such counterparty's 
losses, if any, resulting from marking to market the counterparty's 
Covered Agency Transactions with the member, or guaranteed to a 
third party by the member, reduced to the extent of the member's 
legally enforceable right of offset or security by (2) the sum of 
such counterparty's gains, if any, resulting from: (a) marking to 
market the counterparty's Covered Agency Transactions with the 
member, guaranteed to the counterparty by the member, cleared by the 
member through a registered clearing agency, or in which the member 
has a first-priority perfected security interest; and (b) any ``in 
the money,'' as defined in paragraph (f)(2)(E)(iii) of FINRA Rule 
4210, amounts of the counterparty's long standby transactions 
written by the member, guaranteed to the counterparty by the member, 
cleared by the member through a registered clearing agency, or in 
which the member has a first-priority perfected security interest. 
Under proposed new paragraph (e)(2)(H)(i)c., a counterparty's 
``excess'' net mark to market loss is defined to mean such 
counterparty's net mark to market loss to the extent it exceeds 
$250,000. As such, by specifying excess net mark to market loss, 
FINRA stated that the proposed rule preserves the $250,000 de 
minimis transfer exception set forth under paragraph (e)(2)(H)(ii)f. 
as adopted pursuant to the 2016 Approval Order. Further, FINRA 
stated that, in the interest of clarity, proposed new paragraph 
(e)(2)(H)(ii)c. expressly provides that members would not be 
required to collect margin, or take capital charges, for 
counterparties' mark to market losses on Covered Agency Transactions 
other than excess net mark to market losses. Last, as discussed 
further below, the proposed rule change would delete paragraph 
(e)(2)(H)(ii)f. in the interest of consolidating the rule language. 
See Notice, 86 FR at 28164, n.26.
    \95\ Current paragraph (e)(2)(H)(ii)d. of the rule contains 
provisions designed to permit members to treat mortgage bankers, as 
defined pursuant to current paragraph (e)(2)(H)(i)h. of the rule, as 
exempt accounts under specified conditions. Because the proposed 
rule change eliminates the distinction between exempt and non-exempt 
accounts for purposes of Covered Agency Transactions, FINRA believes 
this language is no longer needed and proposed deleting this 
language. See Notice, 86 FR at 28164, n.27.
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B. Option for Capital Charge in Lieu of Mark to Market Margin

    The 2021 Amendments would add new paragraph (e)(2)(H)(ii)d. to Rule 
4210.\96\ This paragraph would provide FINRA's broker-dealer members, 
subject to specified conditions and limitations, the option to take a 
capital charge in lieu of collecting margin for a counterparty's excess 
net mark to market loss (that is, the net mark to market loss to the 
extent it exceeds $250,000). Informed by FINRA's engagement with 
members, FINRA believes this approach is appropriate because it would 
help alleviate the competitive disadvantage of smaller firms vis-
[agrave]-vis larger firms. FINRA stated smaller firms expressed concern 
that larger firms can leverage their greater size and scale in 
obtaining margining agreements with their counterparties, and that 
counterparties would prefer to transact with larger firms with which 
margining agreements can more readily be obtained, or with banks that 
are not subject to margin requirements. FINRA also stated that smaller 
firms told FINRA that having the option to take a capital charge, in 
lieu of collecting margin, would help alleviate the competitive 
disadvantage of needing to obtain margining agreements with such 
counterparties because there would be an alternative to collecting 
margin.\97\ To this end, as stated above, the proposed rule change 
includes conditions and limitations that FINRA stated are designed to 
help protect the financial stability of members that opt to take 
capital charges while restricting the ability of the larger members to 
use their capital to compete unfairly with smaller members.\98\ 
Specifically, the proposed new paragraph provides that a member need 
not collect margin for a counterparty's excess net mark to market loss 
under paragraph (e)(2)(H)(ii)c. of the rule, provided that:
---------------------------------------------------------------------------

    \96\ See Notice, 86 FR at 28164.
    \97\ See Notice, 86 FR at 28164; see also FINRA Statement at 25 
(citing Letter from Michael Nicholas, Chief Executive Officer, BDA 
to Ms. Kris Dailey Vice President, Risk Oversight & Operational 
Regulation, FINRA (June 7, 2018) at 1-2 (``BDA 2018 Letter''), 
available at http://d31hzlhk6di2h5.cloudfront.net/20180607/81/e8/1f/28/96174e7b8c13fad4d07fa8aa/BDA_4210_Capital_Charge_.pdf).
    \98\ See Notice, 86 FR at 28164.
---------------------------------------------------------------------------

     The member must deduct the amount of the counterparty's 
unmargined excess net mark to market loss from the member's net capital 
computed as provided in Exchange Act Rule 15c3-1, if the counterparty 
is a non-margin counterparty \99\ or if the excess net mark to market 
loss has not been margined or eliminated by the close of business on 
the next business day after the business day on which such excess net 
mark to market loss arises; \100\
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    \99\ Proposed new paragraph (e)(2)(H)(i)e. defines a 
counterparty as a ``non-margin counterparty'' if the member: (1) 
does not have a right under a written agreement or otherwise to 
collect margin for such counterparty's excess net mark to market 
loss and to liquidate such counterparty's Covered Agency 
Transactions if any such excess net mark to market loss is not 
margined or eliminated within five business days from the date it 
arises; or (2) does not regularly collect margin for such 
counterparty's excess net mark to market loss. See Amendment No. 1 
(2021); see also section II.D. below for a discussion of 
modification to proposed definition of non-margin counterparty.
    \100\ See proposed paragraph (e)(2)(H)(ii)d.1. in Exhibit 5 to 
the proposal.
---------------------------------------------------------------------------

     If the member has any non-margin counterparties, the 
member must establish and enforce risk management procedures reasonably 
designed to ensure that the member would not exceed either of the 
limits specified in paragraph (e)(2)(I)(i) of the rule, as proposed to 
be revised pursuant to this proposed rule change,\101\ and that the 
member's net capital deductions under proposed paragraph 
(e)(2)(H)(ii)d.1. of the rule for all accounts combined will not exceed 
$25 million; \102\
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    \101\ Current paragraph (e)(2)(I) sets forth specified 
concentration thresholds. As discussed further below in section 
II.C, the rule change would make conforming revisions to the rule.
    \102\ See proposed paragraph (e)(2)(H)(ii)d.2. in Exhibit 5 to 
the proposal.
---------------------------------------------------------------------------

     If the member's net capital deductions under paragraph 
(e)(2)(H)(ii)d.1. of the rule for all accounts combined exceed $25 
million for five consecutive business days, the member must give prompt 
written notice to FINRA. If the member's net capital deductions under 
paragraph (e)(2)(H)(ii)d.1. of the rule for all accounts combined 
exceed the lesser of $30 million or 25% of the member's tentative net 
capital,\103\ as such term is defined in Exchange Act Rule 15c3-1, for 
five consecutive business days, the member may not enter into any new 
Covered Agency Transactions with any non-margin counterparty other than 
risk-reducing transactions, and must also, to the extent of its rights, 
promptly collect margin for each counterparty's excess net mark to 
market loss and promptly liquidate the Covered Agency transactions of 
any counterparty whose excess net mark to market loss is not margined 
or eliminated within five business days from the date it arises, unless 
FINRA has specifically granted the member additional time; \104\ and
---------------------------------------------------------------------------

    \103\ This is referred to collectively as the 25% TNC/$30MM 
Threshold for purposes of this order.
    \104\ See proposed paragraph (e)(2)(H)(ii)d.3. in Exhibit 5 to 
the proposal.
---------------------------------------------------------------------------

     The member must submit to FINRA such information regarding 
its unmargined net mark to market losses, non-margin counterparties and 
related capital charges, in such form and manner, as FINRA shall 
prescribe by Regulatory Notice or similar communication.\105\
---------------------------------------------------------------------------

    \105\ See Notice, 86 FR at 28164. See also proposed paragraph 
(e)(2)(H)(ii)d.4. in Exhibit 5 to the proposal.
---------------------------------------------------------------------------

C. Streamlining and Consolidation of Rule Language; Conforming 
Revisions

    In support of the amendments discussed above, FINRA has proposed 
several amendments to the current rule designed to streamline and 
consolidate the rule language and otherwise make conforming revisions. 
Generally, these amendments are intended to, among other things: (1) 
consolidate language related to certain exceptions regarding the de 
minimis transfer amount and $10 million gross open position amount and 
introduce the term ``small cash counterparty''; (2) remove defined 
terms that are no longer relevant; (3) conform and consolidate language 
related to excepted counterparties and risk limits; (4) revise existing 
rule text to reflect the elimination of the two percent maintenance 
margin requirement; and (5) revise related supplemental material to 
conform to the proposed rule changes. These proposed changes are 
described in greater detail below.
     The proposed rule change would consolidate language 
related to the $250,000 de minimis transfer exception and the $10 
million gross open position exception while, as discussed above,

[[Page 50212]]

preserving these exceptions in substance. FINRA stated that the 
$250,000 de minimis transfer exception is preserved because paragraph 
(e)(2)(H)(ii)c. under the revised rule specifies that the members shall 
collect margin for each counterparty's excess net mark to margin loss, 
unless otherwise provided under paragraph (e)(2)(H)(ii)d. of the rule 
(that is, the provisions under the proposed rule change that permit a 
member to take a capital charge in lieu of collecting margin, subject 
to specified conditions).\106\ The proposed rule change deletes 
paragraph (e)(2)(H)(ii)f., which currently addresses the de minimis 
exception and would be rendered redundant by the rule change. With 
respect to the current $10 million gross open position exception, FINRA 
proposes to revise paragraph (e)(2)(H)(ii)a. of the rule, which 
identifies the types of counterparties that are excepted from the 
rule's margin requirements, to include a ``small cash counterparty.'' 
Proposed new paragraph (e)(2)(H)(i)h. would provide that a counterparty 
is a ``small cash counterparty'' if:
---------------------------------------------------------------------------

    \106\ See Notice, 86 FR at 28165.
---------------------------------------------------------------------------

    [cir] The absolute dollar value of all of such counterparty's open 
Covered Agency Transactions with, or guaranteed by, the member is $10 
million or less in the aggregate, when computed net of any settled 
position of the counterparty held at the member that is deliverable 
under such open Covered Agency Transactions and which the counterparty 
intends to deliver; \107\
---------------------------------------------------------------------------

    \107\ See proposed paragraph (e)(2)(H)(i)h.1. in Exhibit 5 to 
the proposal.
---------------------------------------------------------------------------

    [cir] The original contractual settlement date for all such open 
Covered Agency Transactions is in the month of the trade date for such 
transactions or in the month succeeding the trade date for such 
transactions; \108\
---------------------------------------------------------------------------

    \108\ See proposed paragraph (e)(2)(H)(i)h.2. in Exhibit 5 to 
the proposal.
---------------------------------------------------------------------------

    [cir] The counterparty regularly settles its Covered Agency 
Transactions on a delivery-versus-payment (``DVP'') basis or for cash; 
\109\ and
---------------------------------------------------------------------------

    \109\ See proposed paragraph (e)(2)(H)(i)h.3. in Exhibit 5 to 
the proposal.
---------------------------------------------------------------------------

    [cir] The counterparty does not, in connection with its Covered 
Agency Transactions with, or guaranteed by, the member, engage in 
dollar rolls, as defined in Rule 6710(z), or round robin trades,\110\ 
or use other financing techniques.\111\
---------------------------------------------------------------------------

    \110\ The term ``round robin'' is defined under current 
paragraph (e)(2)(H)(i)i. of the rule and, pursuant to the rule 
change, would be redesignated as paragraph (e)(2)(H)(i)g., without 
any change.
    \111\ See proposed paragraph (e)(2)(H)(i)h.4. in Exhibit 5 to 
the proposal.
---------------------------------------------------------------------------

    The above elements, according to FINRA, are substantially similar 
to the elements that are currently associated with the exception as set 
forth under current paragraph (e)(2)(H)(ii)c.2., which would be 
deleted, along with the definition of ``gross open position'' under 
paragraph (e)(2)(H)(i)e., which would be rendered redundant by the rule 
change.\112\ The new proposed language reflects that the scope of 
transactions addressed by the rule include Covered Agency Transactions 
with a counterparty that are guaranteed by the member.
---------------------------------------------------------------------------

    \112\ See Notice, 86 FR at 28165.
---------------------------------------------------------------------------

     FINRA proposes to delete the definition of ``bilateral 
transaction'' set forth in current paragraph (e)(2)(H)(i)a. The 
definition is used in connection with the provisions under the current 
rule relating to margin treatment for exempt accounts under paragraph 
(e)(2)(H)(ii)d. and for non-exempt accounts under paragraph 
(e)(2)(H)(ii)e., both of which paragraphs, as discussed above, FINRA 
proposes to delete pursuant to the rule change. Further, FINRA states 
that the term ``bilateral transaction'' is unduly narrow given that the 
proposed revised definition of ``counterparty'' would have the effect 
of clarifying that the rule's scope includes transactions guaranteed by 
the member.\113\
---------------------------------------------------------------------------

    \113\ See Notice, 86 FR at 28165.
---------------------------------------------------------------------------

     FINRA proposes to delete the definition of the term 
``deficiency'' set forth in current paragraph (e)(2)(H)(i)d. Under the 
current rule, the term is designed in part to reference required but 
uncollected maintenance margin for Covered Agency Transactions. Because 
the rule change proposes to eliminate the maintenance margin 
requirement, FINRA believes that the term is not needed.\114\
---------------------------------------------------------------------------

    \114\ See Notice, 86 FR at 28165.
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     Current paragraph (e)(2)(H)(ii)a. addresses the scope of 
paragraph (e)(2)(H) and certain types of counterparties that are 
excepted from the rule, provided the member makes and enforces written 
risk limits pursuant to paragraph (e)(2)(H)(ii)b. Current paragraph 
(e)(2)(H)(ii)b. contains the core language under the rule relating to 
risk limits. FINRA is proposing to revise both paragraphs to conform 
with the changes proposed in the 2021 Amendments and consolidate the 
language relating to written risk limits in these paragraphs within 
paragraph (e)(2)(H)(ii)b. Paragraph (e)(2)(H)(ii)a.1. would be revised 
to read: ``1. a member is not required to collect margin, or to take 
capital charges in lieu of collecting such margin, for a counterparty's 
excess net mark to market loss if such counterparty is a small cash 
counterparty, registered clearing agency, Federal banking agency, as 
defined in 12 U.S.C. 1813(z), central bank, multinational central bank, 
foreign sovereign, multilateral development bank, or the Bank for 
International Settlements; and . . .'' \115\ Paragraph 
(e)(2)(H)(ii)a.2. would be revised to read: ``2. a member is not 
required to include a counterparty's Covered Agency Transactions in 
multifamily housing securities or project loan program securities in 
the computation of such counterparty's net mark to market loss, 
provided . . .'' \116\ Paragraph (e)(2)(H)(ii)a.2.A. would not be 
changed, other than to be redesignated as paragraph (e)(2)(H)(ii)a.2. 
Paragraph (e)(2)(H)(ii)a.2.B. would be eliminated as redundant \117\ 
because, correspondingly, paragraph (e)(2)(H)(ii)b. would be revised to 
read: ``A member that engages in Covered Agency Transactions with any 
counterparty shall make a determination in writing of a risk limit for 
each such counterparty, including any counterparty specified in 
paragraph (e)(2)(H)(ii)a.1. of this Rule, that the

[[Page 50213]]

member shall enforce. The risk limit for a counterparty shall cover all 
of the counterparty's Covered Agency Transactions with the member or 
guaranteed to a third party by the member, including Covered Agency 
Transactions specified in paragraph (e)(2)(H)(ii)a.2. of this Rule. The 
risk limit determination shall be made by a designated credit risk 
officer or credit risk committee in accordance with the member's 
written risk policies and procedures.'' \118\
---------------------------------------------------------------------------

    \115\ The proposed language in the paragraph reflects FINRA's 
proposed establishment of the option to take a net capital charge in 
lieu of collecting margin. Further, FINRA stated that, for clarity, 
the proposed rule change adds registered clearing agencies to the 
types of counterparties that are within the exception pursuant to 
paragraph (e)(2)(H)(ii)a. as revised. FINRA believes that this 
preserves the treatment of registered clearing agencies under the 
rule in light of the proposed deletion of current paragraph 
(e)(2)(H)(ii)c. In this regard, also in the interest of clarity, 
FINRA proposes to add new paragraph (e)(2)(H)(i)f. defining the term 
``registered clearing agency.'' See Notice, 86 FR at 28165, n.39.
    \116\ Under current paragraph (e)(2)(H)(ii)a.2., a member is not 
required to apply the margin requirements of paragraph (e)(2)(H) to 
Covered Agency Transactions with a counterparty in multifamily 
housing securities or project loan program securities, provided the 
securities meet the specified conditions under the rule and the 
member makes and enforces the written risk limit determinations as 
specified under the rule. FINRA stated that the proposed rule change 
does not change the treatment of multifamily housing securities or 
project loan program securities under the current rule other than to 
clarify, in express terms, that a member is not required to include 
a counterparty's Covered Agency Transactions in multifamily housing 
securities or project loan program securities in the computation of 
such counterparty's net mark to market loss. See Notice, 86 FR at 
28165, n.40.
    \117\ See proposed paragraph (e)(2)(H)(ii)a. in Exhibit 5 to the 
proposal.
    \118\ See proposed paragraph (e)(2)(H)(ii)b. in Exhibit 5 to the 
proposal.
---------------------------------------------------------------------------

     Paragraph (e)(2)(I) under FINRA Rule 4210 addresses 
concentration thresholds. FINRA is proposing to make revisions to align 
the paragraph with the proposed new language of paragraph (e)(2)(H), in 
particular the elimination of the maintenance margin requirement and 
the introduction of the proposed new term ``small cash counterparty.'' 
Specifically, FINRA proposes to revise the opening sentence of 
paragraph (e)(2)(I) to read: ``In the event that (i) the net capital 
deductions taken by a member as a result of marked to the market losses 
incurred under paragraphs (e)(2)(F), (e)(2)(G) (exclusive of the 
percentage requirements established thereunder), or (e)(2)(H)(ii)d.1. 
of this Rule, plus any unmargined net mark to market losses below 
$250,000 or of small cash counterparties exceed . . .'' \119\ Current 
paragraph (e)(2)(I)(i)c. would be redesignated as (e)(2)(I)(ii) and 
would read: ``(ii) such excess as calculated in paragraph (e)(2)(I)(i) 
of this Rule continues to exist on the fifth business day after it was 
incurred . . .'' The final clause of the paragraph would be revised to 
read: ``. . . the member shall give prompt written notice to FINRA and 
shall not enter into any new transaction(s) subject to the provisions 
of paragraphs (e)(2)(F), (e)(2)(G) or (e)(2)(H) of this Rule that would 
result in an increase in the amount of such excess.''
---------------------------------------------------------------------------

    \119\ See proposed paragraph (e)(2)(I) in Exhibit 5 to the 
proposal.
---------------------------------------------------------------------------

     Paragraph (f)(6) under FINRA Rule 4210 addresses the time 
within which margin or ``mark to market'' must be obtained. FINRA 
proposes to delete the phrase ``other than that required under 
paragraph (e)(2)(H) of this Rule,'' so the rule, as revised, would 
read: ``The amount of margin or `mark to market' required by any 
provision of this Rule shall be obtained as promptly as possible and in 
any event within 15 business days from the date such deficiency 
occurred, unless FINRA has specifically granted the member additional 
time.'' FINRA believes this is appropriate given the proposed 
elimination of current paragraph (e)(2)(H)(ii)d. and paragraph 
(e)(2)(H)(ii)e. of the rule, both of which set forth, among other 
things, specified time frames for collection of mark to market losses 
or deficiencies, as appropriate, and liquidation of positions that are 
specific to Covered Agency Transactions.\120\
---------------------------------------------------------------------------

    \120\ See Notice, 86 FR at 28166.
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     Current Supplemental Material .02 addresses the 
requirement to establish monitoring procedures with respect to mortgage 
bankers, for purposes of treating them as exempt accounts pursuant to 
current paragraph (e)(2)(H)(ii)d. Current Supplemental Material .03 
addresses how the cure of mark to market loss or deficiency, as the 
term mark to market loss or deficiency is defined under the current 
rule, may eliminate the need to liquidate positions. Current 
Supplemental Material .04 addresses determining whether an account 
qualifies as an exempt account. The proposed rule change would render 
each of these provisions unnecessary, given that the proposed rule 
change would eliminate the need to distinguish exempt versus non-exempt 
accounts (including the language targeted toward mortgage bankers) and 
eliminates the liquidation provisions under current paragraph 
(e)(2)(H)(ii)d. and paragraph (e)(2)(H)(ii)e. of the rule.\121\ FINRA 
proposes to redesignate current Supplemental Material .05 as 
Supplemental Material .03.\122\
---------------------------------------------------------------------------

    \121\ See Notice, 86 FR at 28166.
    \122\ See Supplemental Material provisions in Exhibit 5 to the 
proposal.
---------------------------------------------------------------------------

    Subject to Commission approval of the proposed rule change, FINRA 
proposed it would announce the effective date of the proposed rule 
change in a Regulatory Notice to be published no later than 60 days 
following Commission approval. FINRA stated that the effective date 
will be no later than 120 days following publication of the Regulatory 
Notice announcing Commission approval.\123\
---------------------------------------------------------------------------

    \123\ See discussion of Amendment No. 1 (2021) in section III.E. 
below regarding the proposed adjustment of the implementation date. 
See also Amendment No. 1 (2021) at 20. FINRA stated that the 
proposed rule change would not impact members that are funding 
portals or that have elected to be treated as capital acquisition 
brokers, given that such members are not subject to FINRA Rule 4210. 
See Notice, 86 FR at 28166, n.45. The term ``funding portal'' is 
defined in Rule 100(b)(5) of FINRA's Funding Portal Rules. The term 
``capital acquisition broker'' is defined in Rule 016(c) of FINRA's 
Capital Acquisition Broker Rules.
---------------------------------------------------------------------------

D. Amendment No. 1 (2021)

    In Amendment No. 1 (2021) to the proposed rule change, FINRA 
proposed to: (1) modify the definition of ``non-margin counterparty'' 
to exclude small cash counterparties and other exempted counterparties; 
and (2) define a FINRA member's ``specified net capital deductions'' as 
the net capital deductions required by paragraph (e)(2)(H)(ii)d.1. of 
FINRA Rule 4210 with respect to all unmargined excess net mark to 
market losses of its counterparties, except to the extent that the 
member, in good faith, expects such excess net mark to market losses to 
be margined by the close of business on the fifth business day after 
they arose.\124\ In addition, Amendment No. 1 (2021) states that, if 
the Commission approves the proposed rule change, as modified by 
Amendment No. 1 (2021), FINRA will announce the effective date of the 
proposed rule change, as modified by Amendment No. 1 (2021), in a 
Regulatory Notice to be published no later than 60 days following 
Commission approval. The effective date would be between nine and ten 
months following the Commission's approval.\125\
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    \124\ Amendment No. 1 (2021) also contains several conforming 
changes to paragraph numbering to accommodate the proposed 
modifications to the rule text. See Exhibit 4 to Amendment No. 1 
(2021).
    \125\ See Amendment No. 1 (2021); 2021 Order Instituting 
Proceedings, 86 FR at 47665.
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III. Commission Discussion and Findings

    After careful review of the proposed rule change, as modified by 
Amendment No. 1 (2021), comment letters, FINRA's responses to the 
comments, the Petition for Review, and the statements received in 
response to the Petition for Review, as discussed below, the Commission 
finds that the proposed rule change, as modified by Amendment No. 1 
(2021), is consistent with the requirements of the Exchange Act and the 
rules and regulations thereunder applicable to a national securities 
association.\126\ Specifically, for the reasons discussed below, the 
Commission finds that the proposed rule change, as modified by 
Amendment No. 1 (2021), is consistent

[[Page 50214]]

with Section 15A(b)(6) of the Exchange Act,\127\ which requires, among 
other things, that FINRA rules be designed to prevent fraudulent and 
manipulative acts and practices, to promote just and equitable 
principles of trade, to facilitate transactions in securities, to 
remove impediments to and perfect the mechanism of a free and open 
market and, in general, to protect investors and the public interest. 
The Commission also finds that the proposed rule change, as modified by 
Amendment No. 1 (2021), is consistent with Section 15A(b)(9) of the 
Exchange Act,\128\ which requires that the rules of a national 
securities association must not impose any burden on competition not 
necessary or appropriate in furtherance of the purposes of the Exchange 
Act.
---------------------------------------------------------------------------

    \126\ In approving this rule change, the Commission has 
considered the rule's impact on efficiency, competition, and capital 
formation. See 15 U.S.C. 78c(f). See, e.g., section III.A. 
(discussing alleviation of competitive impacts on broker-dealers 
with the elimination of the two percent maintenance margin 
requirement for non-exempt accounts and the option to take a capital 
charge in lieu of collecting the excess net mark to market loss, 
subject to a cap; competitive concerns raised by commenters 
regarding smaller firms exiting the market resulting in a 
concentration of larger firms; and enhancements in efficiency in 
streamlining and consolidating the rule text).
    \127\ 15 U.S.C. 78o-3(b)(6).
    \128\ 15 U.S.C. 78o-3(b)(9).
---------------------------------------------------------------------------

A. The Elimination of the Two Percent Maintenance Margin Requirement, 
the Optional Capital in Lieu of Margin Charge, and the Streamlining of 
the Rule Text are Consistent With the Exchange Act

1. Elimination of the Two Percent Maintenance Margin for Non-Exempt 
Accounts
a. Comments Received on the Proposal
    As discussed in section II.A. above, FINRA proposed to eliminate 
the two percent maintenance margin requirement that would apply to non-
exempt accounts under the current rule. The Commission received one 
comment supporting the proposed rule change to eliminate the two 
percent maintenance margin requirement for non-exempt accounts.\129\
---------------------------------------------------------------------------

    \129\ See Letter from Chris Killian, Managing Director, 
Securitization, Corporate Credit, Libor, Asset Management Group of 
SIFMA (June 15, 2021) (``SIFMA AMG Letter'') at 1.
---------------------------------------------------------------------------

b. FINRA's Rationale for the Proposed Change
    FINRA stated that eliminating the two percent maintenance margin 
requirement for non-exempt accounts is intended to reduce costs for 
FINRA members and address any perceived competitive disadvantage 
between FINRA members and banks regarding Covered Agency Transactions. 
FINRA also stated that elimination of the two percent maintenance 
margin requirement will reduce costs and provide operational relief to 
FINRA members, as they will not need to enter into separate custodial 
arrangements with third-party banks to custody the maintenance margin 
of counterparties that cannot deposit margin collateral directly with a 
broker-dealer.\130\ By simplifying the current rule, mitigating 
concerns about regulatory compliance costs and allowing FINRA members 
to compete in the market more equally with non-FINRA members, FINRA 
stated that the elimination of the two percent maintenance margin 
requirement for non-exempt accounts promotes a more just and equitable 
market by promoting competition and efficiency, which will benefit 
investors and the public interest.\131\
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    \130\ See FINRA Statement at 23-24, 33; Notice, 86 FR at 28163-
64.
    \131\ See FINRA Statement at 23-24.
---------------------------------------------------------------------------

c. Commission Discussion and Findings
    The elimination of the two percent maintenance margin will reduce 
operational burdens and compliance costs for broker-dealers because 
they will no longer need to monitor which accounts are exempt or non-
exempt for purposes of the Covered Agency Transaction margin 
requirements. In addition, the two percent maintenance margin 
requirement only would have applied to a small number of accounts. 
Monitoring which accounts are non-exempt accounts and collecting 
maintenance margin for these accounts is operationally burdensome and 
out of proportion with the number and size of the affected accounts. 
Elimination of the two percent maintenance margin requirement for non-
exempt accounts also will alleviate competitive impacts for FINRA-
member broker-dealers in comparison to banks that, depending on their 
size, may: (1) follow best practices of exchanging variation margin 
recommended by the Treasury Markets Practice Group (``TMPG''),\132\ or 
(2) not otherwise be subject to margin requirements with respect to 
Covered Agency Transactions. Therefore, under the proposed rule 
changes, the elimination of the maintenance margin requirement and the 
remaining requirement to collect the excess net mark to market loss (or 
take a capital charge, subject to specified terms and conditions) will 
allow broker-dealers to more effectively compete with banks that either 
only collect variation margin from their counterparties for Covered 
Agency Transactions or that do not collect any margin. Consequently, 
the elimination of the two percent maintenance margin requirement will 
reduce regulatory requirements for FINRA broker-dealers while promoting 
consistent margin practices among FINRA members.
---------------------------------------------------------------------------

    \132\ See Margining in Agency MBS Trading (Nov. 2012), available 
at https://www.newyorkfed.org/medialibrary/microsites/tmpg/files/margining_tmpg_11142012.pdf (``TMPG Report''). The TMPG Report 
recommends the best practice of exchanging variation margin for 
dealer banks. The TMPG is a group of market professionals that 
participate in the Covered Agency Transaction market and is 
sponsored by the Federal Reserve Bank of New York.
---------------------------------------------------------------------------

    While the proposed rule change eliminates the two percent 
maintenance margin requirement for non-exempt accounts, broker-dealers 
will continue to be protected from the risks of unsecured credit 
exposures arising from Covered Agency Transactions because, under the 
proposed rule change, they must collect the excess net market to market 
loss from a counterparty or take a capital charge (subject to specified 
conditions and limitations), unless an exception applies. Further, 
under current Rule 4210, broker-dealers may collect additional margin 
(i.e., house margin) from a counterparty above the minimums required by 
the Covered Agency Transaction margin requirements. Finally, under the 
current rule, FINRA broker-dealers must perform a written credit risk 
assessment for each counterparty, which is designed to help them manage 
the risks of Covered Agency Transactions.
    Consequently, this amendment will help to facilitate trading in 
Covered Agency Transactions by reducing the competitive burdens of the 
margin requirements for FINRA member broker-dealers, including smaller 
broker-dealers. This will promote competition by reducing the costs 
associated with collecting maintenance margin from a counterparty and 
permitting broker-dealers of all sizes to compete more effectively with 
banks that are not required to collect maintenance margin or that do 
not collect any margin from their counterparties for Covered Agency 
Transactions. Finally, the continued requirements to collect the excess 
net mark to market loss from a counterparty and credit risk assessment 
procedures will continue to protect FINRA-member broker-dealers and 
investors from the risks of unsecured credit exposures in the Covered 
Agency Transaction market.
2. Option for Capital Charge in Lieu of Collecting Excess Net Mark to 
Market Loss
a. Comments Received on Proposal
    As discussed in section II.B. above, FINRA proposed, subject to 
specified conditions and limitations, to provide FINRA broker-dealers 
the option to take a capital charge in lieu of collecting a 
counterparty's excess net mark to market loss (i.e., the net mark to 
market loss to the extent it exceeds $250,000). One commenter indicated 
that its members were appreciative of the proposed rule change stating 
that it was

[[Page 50215]]

consistent with other provisions of FINRA Rule 4210 that permit broker-
dealers to take capital charges rather than collect margin for 
transactions involving securities of high credit quality.\133\
---------------------------------------------------------------------------

    \133\ See Letter from Christopher B. Killian, Managing Director 
Securitization, Corporate Credit, Libor, SIFMA (June 15, 2021) 
(``SIFMA Letter'') at 5.
---------------------------------------------------------------------------

    Other commenters opposed the proposed capital charge in lieu of 
margin stating it would affect liquidity by requiring smaller broker-
dealers to take capital charges because they do not have and cannot 
obtain margin agreements or MSFTAs from their counterparties.\134\ For 
example, the Petitioners, in delineating the types of institutions that 
participate in the agency mortgage-backed securities market as 
investors, stated that pension funds and state agencies may be 
prohibited by their charters from pledging assets, and as a result 
would be unable to post margin.\135\ Petitioners stated that, partially 
as a result of counterparties who are unable to post margin, because of 
the limitation imposed by the 25% TNC/$30MM Threshold, the ability of 
FINRA members to introduce liquidity into the market during periods of 
unusual volatility will be drastically limited.\136\ Commenters also 
stated that these smaller broker-dealers would need to maintain a 
substantial amount of excess net capital in order to comply with the 
proposed rule, which could reduce liquidity and impair regulatory 
capital under certain market conditions.\137\ These firms, according to 
commenters, would be unable to commit to purchasing additional mortgage 
loans until outstanding trades settled, which they stated could 
prohibit many smaller broker-dealers (including minority, women, and 
veteran owned firms) from engaging in Covered Agency Transactions or 
curtail their business.\138\ These commenters stated that this, in 
turn, could reduce market liquidity and disrupt the mortgage 
origination process which could harm market participants and customers.
---------------------------------------------------------------------------

    \134\ See Letter from Duncan F. Williams, President, Duncan-
Williams Inc., and Brad Jones, Executive Vice President, Managing 
Director--Correspondent Division, SouthState Bank N.A. (May 10, 
2022) (``Duncan-Williams/SouthState Letter'') at 2-3; Letter from 
Michael Decker, Senior Vice President, BDA on behalf of CastleOak 
Securities; Loop Capital Markets; MFR Securities Inc.; Penserra 
Securities, R. Seelaus & Co. LLC; Siebert Williams Shank & Co., LLC; 
and Tigress Financial Parter to Vanessa Countryman, Secretary, 
Commission (May 10, 2022) (``BDA Small Firms Letter'') at 2-3; 
Letter from DiAnne Calabrisotto, Chief Operating Officer, Siebert 
Williams Shank & Co., LLC (May 10, 2022) (``Siebert Letter'') at 2; 
Letter from Stephen Berkeley, Chief Compliance Officer and 
Regulatory Counsel, Loop Capital Markets LLC (May 12, 2022) (``Loop 
Capital Letter'') at 2.
    \135\ See Petition for Review at 8, 33. Petitioners also stated 
that registered investment companies cannot re-pledge collateral. 
Id.
    \136\ See Petition for Review at 30, 33.
    \137\ See Duncan-Williams/SouthState Letter at 3-4; BDA Small 
Firms Letter at 2-3; Letter from Chirag G. Shah, President and Chief 
Executive Officer, Performance Trust Capital Partners (May 10, 2022) 
(``Performance Trust Capital Letter'') at 2; Letter from Wendy L. 
Brooks, Senior Managing Director, Mesirow Financial, Inc. (May 3, 
2022) (``Mesirow Letter'') at 2.
    \138\ See Letter from David R. Jones, CastleOak Securities, L.P. 
(May 10, 2022) (``CastleOak Securities Letter'') at 1-2; Weichert 
Letters at 2; Letter from Kirk R. Malmberg, President and Chief 
Executive Officer, Federal Home Loan Bank of Atlanta (May 10, 2022) 
(``Malmberg Letter 2'') at 2; Letter from Larry W. Bowden, Executive 
Vice President, Stephens, Inc. (May 10, 2022) (``Stephens Letter'') 
at 3; BDA Small Firms Letter at 2-3; Williams/SouthState Letter at 
3; Siebert Letter at 2; Performance Trust Capital Letter at 2.
---------------------------------------------------------------------------

    Commenters also stated that the proposed rule change would result 
in potential anti-competitive impacts on small and medium-sized broker-
dealers, including women, veteran, and minority-owned firms.\139\ 
Specifically, these commenters stated that imposing margin requirements 
or 100% capital charges on Covered Agency Transactions would cause 
smaller and mid-sized firms (including women, veteran, and minority-
owned firms) to exit the Covered Agency Transaction market or 
significantly decrease their ability to transact in the market, 
resulting in greater concentration among fewer market participants, 
reducing access to the Covered Agency Transaction market or negatively 
affecting market liquidity.\140\ These commenters stated that the 
proposed amendments would cause them to exit the market or decrease 
their ability to transact in the market because customers would prefer 
to transact with banks that are not subject to margin requirements, 
many customers would be unwilling to enter into margin agreements, the 
operational and compliance costs of engaging in Covered Agency 
Transactions would increase significantly, and excessive margin 
requirements and capital charges would be involved for smaller firms 
compared to larger firms even though the transactions are riskless to 
the firm. Other commenters also stated that the proposed requirements, 
either in whole or in part, are not suitable for Specified Pool 
Transactions and CMOs.\141\ One commenter also expressed concern that 
an early survey of its customers indicated that many of its customers 
are uncomfortable with executing an MSFTA that indicates that there is 
a potential liquidity event or margin call in a volatile market, even 
if unlikely, and that bank affiliated firms do not require the 
execution of such a document.\142\ One commenter suggested that the 
proposed capital charges in lieu of margin should be applied at 10% 
rather than at 100% of the excess net mark to market loss.\143\ 
Commenters also expressed concerns that the proposed rule change would 
have a disparate impact on underserved communities which smaller firms 
typically serve and stated that FINRA did not specifically consider the 
consequences and impact the proposal would have on the housing finance 
sector and access to the liquidity for underserved communities.\144\ 
Consequently, commenters believe that the proposed rule change will 
cause smaller broker-dealers to exit the market, resulting in decreased 
competition and liquidity in the Covered Agency Transaction 
market.\145\
---------------------------------------------------------------------------

    \139\ See SIFMA Letter at 2-3; Letter from Michael Decker, 
Senior Vice President, Public Policy, Bond Dealers of America (June 
15, 2021) (``BDA Letter'') at 4-5; Letter from Thomas J. Fleming & 
Adrienne M. Ward, Olshan, on behalf of Brean Capital, LLC (June 15, 
2021) (``Brean Capital Letter'') at 18-21; Letter from Kirk R. 
Malmberg, President and Chief Executive Officer, Federal Home Loan 
Bank of Atlanta (Jan. 18, 2022) at 1-2 (``Malmberg Letter 1''); 
Letter from Senator John Boozman, Senator Thom Tillis, and Senator 
Cynthia M. Lummis (Jan. 10, 2022) (``Boozman et al Letter'') at 1-2; 
Petition for Review at 26-29; Duncan-Williams/SouthState Letter at 
2-3; Stephens Letter at 2; Mesirow Letter at 2; Loop Capital Letter 
at 2.
    \140\ See SIFMA Letter at 2-3; BDA Letter at 4-5; Brean Capital 
Letter at 18-20; Malmberg Letter 1 at 1-2; Boozman et al Letter at 
1-2; Petition for Review at 27-31; Stephens Letter at 2; BDA Small 
Firms Letter at 3.
    \141\ See Letter from Chris Melton, Individual (Aug. 2, 2021) 
(``Melton Letter'') at 1; SIFMA Letter at 1-3.
    \142\ See Stephens Letter at 2.
    \143\ See Brean Capital Letter at 25.
    \144\ See Petition for Review at 41-42; Letter from Alanna 
McCargo, President, Government National Mortgage Association (Jan. 
20, 2022) at 1-2.
    \145\ See Petition for Review at 30-31.
---------------------------------------------------------------------------

    Further, the Petitioners stated that the proposed rule change would 
increase systemic risk, as the option to take a capital charge in lieu 
of margin with its associated 25% TNC/$30MM Threshold, would force 
regional broker-dealers to suspend trading in Covered Agency 
Transactions after a few trades or to liquidate customer positions, and 
cause customers to move their business to banks which could transform 
moderate market volatility into a liquidity crisis.\146\
---------------------------------------------------------------------------

    \146\ Petitioners also stated that the proposed rule change 
would enhance systemic risk as a result of several factors. These 
factors include: (1) removing liquidity from agency mortgage-backed 
security markets; (2) introducing uncertainty into the market due to 
the difference between trade prices and mark to market losses for 
calculation of margin; (3) failing to provide a solution to the 
``chain'' fail problem; (4) increasing the bargaining power of 
primary dealers to the detriment of introducing brokers; and (5) 
encouraging a shift in business to banks by broker-dealers with bank 
affiliates. See Petition for Review at 31-33, 37-38. Petitioners 
also stated that the 25% TNC/$30MM Threshold will limit large 
broker-dealers from introducing liquidity in the market in times of 
stress which may add volatility to the market. See Petition for 
Review at 30. See section III.B. below for a discussion of the 
concerns commenters raised regarding chain of fails and the 
calculation of variation margin.

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[[Page 50216]]

    Petitioners also stated that the Division staff, in approving the 
2021 Amendments by delegated authority, failed to engage in reasoned 
decision-making, and that FINRA never identified the market 
participants it engaged with or the substance of the conversations with 
them. Petitioners further stated that FINRA did not offer any evidence 
or data to support the need for the proposed changes or the need for 
FINRA to establish a margin regime for Covered Agency 
Transactions.\147\ Petitioners also stated that the proposed rule 
change is unnecessary and an abuse of discretion and that the rule is 
unworkable, increases systemic risk, and will have a catastrophic 
effect on regional broker-dealers. They stated that despite FINRA's 
efforts to mitigate the harms to smaller market participants and lessen 
the burdens that it will impose on competition, these burdens remain 
significant, unnecessary and inappropriate.\148\
---------------------------------------------------------------------------

    \147\ See Petition for Review at 43-45.
    \148\ See Letter from Thomas J. Fleming, Adrienne M. Ward, 
Olshan, David H. Thompson, Cooper & Kirk, PLLC Harold Reeves, Esq., 
Cooper & Kirk, PLL on behalf of BDA and Brean Capital (Sept. 10, 
2021) (``BDA and Brean Capital Letter'') at 32-42; Petition for 
Review at 26-27.
---------------------------------------------------------------------------

    Finally, one commenter stated that the March 2020 period of 
volatility during the COVID-19 pandemic provided a perfect example of a 
situation when margin flexibility on the part of broker-dealers was 
necessary \149\ and that if this situation were replicated in the 
future, the amendments would effectively remove the ability of broker-
dealers to exercise appropriate discretion with respect to their 
clients' positions and would contribute to market stress.\150\
---------------------------------------------------------------------------

    \149\ See MBA Letter at 2.
    \150\ See MBA Letter at 2.
---------------------------------------------------------------------------

b. FINRA's Response to Comments
    In response to the comments to the Notice, FINRA stated that it has 
engaged with industry participants extensively on their concerns, and 
has addressed them on multiple occasions since the process of 
soliciting comment on requirements for Covered Agency Transactions 
began in January 2014 with the publication of Regulatory Notice 14-02 
and in 2015 with FINRA's original rulemaking for Covered Agency 
Transactions.\151\ FINRA also stated that the original rulemaking is 
necessary because of the risks posed by unsecured credit exposures in 
the Covered Agency Transactions market.\152\
---------------------------------------------------------------------------

    \151\ See Amendment No. 1 (2021) at 4; Exchange Act Release No. 
76148 (Oct. 14, 2015), 80 FR 63603 (Oct. 20, 2015) (Notice of Filing 
of a Proposed Rule Change to Amend FINRA Rule 4210 (Margin 
Requirements) to Establish Margin Requirements for the TBA Market; 
File No. SR-FINRA-2015-036) (``2015 Notice''); Regulatory Notice 14-
02 (Jan. 2014). Even before the publication of these materials, as 
discussed in SR-FINRA-2015-036, FINRA highlighted that it had 
engaged in extensive outreach and consultation with market 
participants and staff of the Federal Reserve Bank of New York and 
the Commission staff. See 2015 Notice, 80 FR at 63604-05. In Partial 
Amendment No. 3 to SR-FINRA-2015-036, FINRA stated that up to that 
time there had been four opportunities for public comment on the 
original rulemaking, beginning with Regulatory Notice 14-02, 
available at https://www.finra.org/rules-guidance/rule-filings/sr-finra-2015-036.
    \152\ See Amendment No. 1 (2021) at 4-5 and 2015 Notice, 80 FR 
at 63615-16.
---------------------------------------------------------------------------

    FINRA also stated that it has addressed, on multiple occasions, the 
need to include Specified Pool Transactions and CMOs within the scope 
of the requirements,\153\ and made key revisions in finalizing the 2016 
Amendments expressly to mitigate any potential impact on smaller firms 
and on activity in the Covered Agency Transaction market, including 
increasing the small cash counterparty exception from $2.5 million to 
$10 million, subject to specified conditions, and modifying the two 
percent maintenance margin requirement, as adopted pursuant to the 
original rulemaking, to create an exception for cash investors that 
otherwise would have been subject to the requirement.\154\
---------------------------------------------------------------------------

    \153\ See Amendment No. 1 (2021) at 5 and 2016 Approval Order, 
81 FR at 40371.
    \154\ See Amendment No. 1 (2021) at 5.
---------------------------------------------------------------------------

    FINRA also exempted mortgage bankers from the maintenance margin 
requirements in the 2016 Amendments; exempted multifamily housing 
securities and project loan program securities from the new margin 
requirements; \155\ and established a $250,000 de minimis transfer 
amount, for a single counterparty, subject to specified conditions, up 
to which members need not collect margin or take a charge to their net 
capital.\156\
---------------------------------------------------------------------------

    \155\ See Amendment No. 1 (2021) at 5-6 and Partial Amendment 
No. 1 to SR-FINRA-2015-036, available at https://www.finra.org/rules-guidance/rule-filings/sr-finra-2015-036.
    \156\ See Amendment No. 1 (2021) at 6 and 2016 Approval Order, 
81 FR at 40368.
---------------------------------------------------------------------------

    Additionally, FINRA stated that once the Commission approved the 
2016 Amendments that it would monitor the impact of the new 
requirements and, if the requirements proved overly onerous or 
otherwise were shown to negatively impact the market, it would consider 
amending such requirements to mitigate the rule's impact.\157\ Industry 
participants requested that FINRA monitor the potential impact of the 
2016 Amendments on smaller and mid-sized firms, and that FINRA extend 
the implementation date of the requirements pending its consideration 
of any potential amendments to the rule.\158\ In response to the 
concerns of industry participants, FINRA also stated that it engaged in 
extensive dialogue, both with industry participants and other 
regulators, including staff of the Commission and the Federal Reserve 
System, for purposes of amending the 2016 Amendments.\159\ Further, 
FINRA extended the implementation date of the margin collection 
requirements pursuant to the 2016 Amendments on multiple 
occasions.\160\
---------------------------------------------------------------------------

    \157\ See Amendment No. 1 (2021) at 6 and Partial Amendment No. 
3 to SR-FINRA-2015-036.
    \158\ See Amendment No. 1 (2021) at 6.
    \159\ See Amendment No. 1 (2021) at 6.
    \160\ See Amendment No. 1 (2021) at 6 and Notice, 86 FR at 
28162.
---------------------------------------------------------------------------

    FINRA stated that it developed the proposed rule change in direct 
response to the concerns of industry participants, and in citing the 
risks posed by unsecured credit exposures that exist in the Covered 
Agency Transaction market, stated that it has proposed two key 
revisions designed to afford relief to industry participants: \161\ (1) 
eliminating the two percent maintenance margin requirement with respect 
to non-exempt accounts for purposes of their Covered Agency 
Transactions; \162\ and (2) subject to specified conditions and limits, 
permitting members to take a capital charge in lieu of collecting 
margin for each counterparty's excess net mark to market loss.\163\ 
FINRA believes the amendments to the original rulemaking as set forth 
in the proposed rule change, with the additional clarifications it has 
provided to commenters, afford industry participants appropriate relief 
and clarity, and that the proposed rule change should be approved.\164\
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    \161\ See Amendment No. 1 (2021) at 6 and Notice, 86 FR at 
28162-63.
    \162\ This proposal is discussed in section III.A.1. above.
    \163\ See Amendment No. 1 (2021) at 6-7. This proposal is 
discussed in section III.A.2. above.
    \164\ See Amendment No. 1 (2021) at 7.
---------------------------------------------------------------------------

    Further, in response to the additional comments received regarding 
the 2021 Order Instituting Proceedings, FINRA stated that commenters 
have repeatedly expressed the same points, including during the 
original rulemaking, which FINRA stated it has repeatedly addressed, 
and that it believes the

[[Page 50217]]

rulemaking is necessary because of the risk posed by unsecured credit 
exposures in the Covered Agency Transaction market.\165\ FINRA also 
stated that recent events in connection with market volatility stemming 
from the COVID-19 pandemic \166\ have illustrated the importance of 
risk and exposure limits,\167\ and that these events reinforce that 
FINRA's attention to unsecured exposures in the Covered Agency 
Transaction market, in view of its significance to the U.S. mortgage 
market and financial system generally, is rationally founded. FINRA 
stated that the Covered Agency Transaction market today is substantial 
and that the regulatory need for attention to this area is no less than 
when FINRA initiated the original rulemaking.\168\
---------------------------------------------------------------------------

    \165\ See FINRA Letter at 4-7. For example, FINRA stated that 
BDA and Brean Capital contended that permitting members to take the 
capital charge in lieu of colleting margin is untenable, that having 
requirements for Covered Agency Transactions would have the effect 
of causing a ``chain'' of fails, that firms will be driven from the 
market and that FINRA has not addressed critical questions as to how 
the requirements will work. In response, FINRA stated that these 
arguments are not novel and that FINRA exhaustively addressed them 
with industry participants throughout the course of the 2016 
Amendments and the development of the proposal. FINRA also stated 
that it provided extensive further explanations in Amendment No. 1 
(2021). See id. at 7.
    \166\ See FINRA Letter at 5, n.17 (citing DERA Report).
    \167\ See FINRA Letter at 5.
    \168\ See FINRA Letter at 6. As of the second quarter of 2021, 
total average daily dollar trading volume for these types of 
products as reflected in FINRA Trade Reporting and Compliance Engine 
(``TRACE'') data was approximately $300 billion. Id. at 5-6.
---------------------------------------------------------------------------

    In response to the Petition for Review and comments that FINRA 
failed to engage in reasoned decision-making or provide evidence or 
data to support the proposal, FINRA stated that record supports the 
narrow amendments under the proposed rule change. FINRA further stated 
that rather than imposing new requirements, the narrow amendments to 
FINRA Rule 4210 in the proposal address--and in fact reduce the 
potential burden of--amendments to FINRA Rule 4210 included in the 2016 
Amendments.\169\ Specifically, in its Statement, FINRA stated that 
permitting FINRA members to take a capital charge in lieu of collecting 
mark to market margin was a change that was specifically motivated by 
its efforts to address concerns that the 2016 Amendments could create 
an unfair disparity between large brokers and small and medium-sized 
brokers, and that various small broker-dealers commented during the 
rulemaking process that being permitted to take a capital charge in 
lieu of margin would help alleviate the competitive disadvantage that 
small and medium-sized firms face in obtaining margin agreements with 
counterparties, as it would provide an alternative to collecting 
margin.\170\ FINRA further stated that in a 2018 letter, BDA, one of 
the Petitioners, requested that FINRA adopt a provision that would 
permit members to take a capital charge in lieu of margin as BDA 
indicated that discussions with two small broker-dealers indicated that 
this would allow those small broker-dealers the ability to remain 
competitive and would not erode their capital.\171\
---------------------------------------------------------------------------

    \169\ See FINRA Statement at 9, and 21-22.
    \170\ See FINRA Statement at 24-25.
    \171\ See FINRA Statement at 25 (citing BDA 2018 Letter). FINRA 
stated that BDA in reciting its own discussions with two smaller 
broker-dealers who expressed support for a capital charge in lieu of 
margin option, wrote that the two smaller broker-dealers believed 
``the Capital Charge Proposal would give them many options to remain 
competitive in [Covered Agency Transactions]'' and that they were 
``not concerned that the Capital Charge Proposal [would] be 
anticompetitive'' or force them to ``erode away their capital in 
order to be competitive.'' BDA 2018 Letter at 2 (cited in FINRA 
Statement at 25).
---------------------------------------------------------------------------

    FINRA further stated that the whole purpose of the 2021 Amendments 
is to respond to the types of concerns raised by smaller firms by 
providing greater flexibility than they have under the current 
rule.\172\ Further, FINRA stated that the proposed rule permits FINRA 
members a limited capacity to take capital charges in lieu of 
collecting margin and thereby assume the risk of counterparty default, 
and that could help FINRA members to establish (or maintain) 
relationships with counterparties who are not willing to post 
margin.\173\
---------------------------------------------------------------------------

    \172\ See FINRA Statement at 33.
    \173\ See FINRA Statement at 33.
---------------------------------------------------------------------------

    FINRA has stated that it intends to monitor the proposed rule's 
implementation and its impact.\174\ FINRA stated it remains committed 
to ensuring that FINRA Rule 4210, as amended, in practice, does not 
disadvantage smaller broker-dealers who are most focused on community 
institutions, including those owned by women, minorities and 
veterans.\175\ FINRA also stated that the proposed rule demonstrates 
FINRA's commitment to smaller firms in action, as FINRA is pro-actively 
responding to concerns raised by market participants and proposing 
appropriate amendments to FINRA Rule 4210.\176\
---------------------------------------------------------------------------

    \174\ See FINRA Statement at 34.
    \175\ See FINRA Statement at 34.
    \176\ See FINRA Statement at 34.
---------------------------------------------------------------------------

    In addition, with respect to comments that FINRA failed to engage 
in reasoned decision making regarding the 2021 Amendments, FINRA stated 
it complied with all applicable procedural requirements.\177\ FINRA 
stated that the Petitioners used the record in the 2021 Amendments to 
take issue with FINRA's adoption of margin requirements for Covered 
Agency Transactions in the 2016 Amendments.\178\ FINRA stated that it 
was not required to re-do the entire rulemaking process that led to the 
approval of the 2016 Amendments to make amendments to the current rule, 
and that the Commission is not required to re-canvass a rulemaking 
process that stretches back to 2014 to approve the 2021 Amendments to 
an already-approved rule change.\179\ FINRA also stated in response to 
Petitioner's comments that it did not disclose who it consulted with in 
the development of the 2021 Amendments as mischaracterizing the 
record.\180\ FINRA stated it set forth the process it undertook to 
develop the 2021 Amendments in the proposal, and that the record 
contains a lengthy and detailed analysis of comments received.\181\ 
Finally, FINRA stated that the rationale for SR-FINRA-2021-010 is 
clearly supported in the administrative record by detailed and rigorous 
assessments of any burden imposed on competition (including thorough 
analysis of economic impact assessments, anticipated benefits, 
anticipated costs, and alternative approaches).\182\
---------------------------------------------------------------------------

    \177\ See FINRA Statement at 29.
    \178\ See FINRA Statement at 29.
    \179\ See FINRA Statement at 29-30.
    \180\ See FINRA Statement at 30.
    \181\ See FINRA Statement at 30.
    \182\ See FINRA Statement at 23.
---------------------------------------------------------------------------

    FINRA stated that the proposed rule change promotes competition by 
leveling the playing field among Covered Agency Transaction market 
participants of all sizes, thereby reducing disruption in this market 
without the loss of any investor protection.\183\ Further, FINRA stated 
by limiting the ability of larger members to take a capital charge, the 
proposal promotes competition in the market, particularly for smaller 
broker-dealers.\184\ FINRA believes that the amendments set forth in 
the proposed rule change strike an appropriate balance in providing 
small and medium-sized FINRA member broker-dealers with an alternative 
to collecting margin, while ensuring that the regulatory objective of 
FINRA Rule 4210, as amended by the proposed rule, is not undermined by 
limiting the

[[Page 50218]]

option to take a capital charge with the 25% TNC/$30MM Threshold.\185\
---------------------------------------------------------------------------

    \183\ See FINRA Statement at 26.
    \184\ See FINRA Statement at 35.
    \185\ See FINRA Statement at 26.
---------------------------------------------------------------------------

    FINRA stated that it disagrees with commenters' concerns that the 
25% TNC/$30MM Threshold is a flaw in the proposal, as the objective of 
the proposed rule change is to encourage the collection of margin.\186\ 
FINRA stated that the purpose of FINRA Rule 4210, as amended by the 
2016 Amendments and 2021 Amendments, is to shore up the practices in 
the Covered Agency Transaction market by encouraging the margining of 
those positions--not to allow members to avoid such requirements 
through the taking of a large net capital charge. FINRA stated that 
allowing firms to take a capital charge in lieu of margin is meant to 
add flexibility to the rule, not to supplant its margin 
requirements.\187\ FINRA stated that in effect, the 25% TNC/$30MM 
Threshold is a risk management mechanism given the introduction of the 
proposed capital charge option.\188\ FINRA stated that for some FINRA 
members, the volume of business may reach the threshold where further 
capital charges cannot be taken, and at that point, the 25% TNC/$30MM 
Threshold would then prevent the member from entering into new Covered 
Agency Transactions with any counterparty that cannot or will not post 
margin.\189\ While the ability of the FINRA member to inject liquidity 
into the Covered Agency Transaction market could potentially be 
reduced, FINRA stated that raising the threshold for permitted capital 
charges would reduce the effectiveness of the 2021 Amendments by 
increasing the FINRA member's exposure to the risk of counterparty 
default and would undermine the goal of promoting and supporting 
competition in the market by allowing larger FINRA members that are 
more able to commit capital to avoid collecting margin.\190\ In 
addition, FINRA stated that permitting a capital charge to substitute 
completely for the collection of margin would undermine the core 
regulatory objectives of the margin requirements for Covered Agency 
Transactions to reduce the risk of unsecured exposures to Covered 
Agency Transactions and to encourage the collection of margin.\191\
---------------------------------------------------------------------------

    \186\ See FINRA Statement at 26.
    \187\ See FINRA Statement at 26.
    \188\ See FINRA Statement at 35.
    \189\ See FINRA Statement at 35.
    \190\ See FINRA Statement at 35.
    \191\ See FINRA Statement at 26-27.
---------------------------------------------------------------------------

    FINRA also stated that permitting capital to substitute wholly for 
the requirement to collect margin would exacerbate, rather than 
address, the disparity between small and medium-sized firms and larger 
competitors, as larger competitors would be able to use their larger 
balance sheets to effectively avoid the margin requirements altogether, 
to the disadvantage small and medium-sized firms.\192\ Because taking a 
capital charge is optional, FINRA stated that members will only commit 
capital in lieu of margin when they believe it appropriately balances 
the benefits and risks.\193\ FINRA stated it intended to keep strong 
incentives to collect margin and use the amendments only to allow 
flexibility in complying with the rule.\194\
---------------------------------------------------------------------------

    \192\ See FINRA Statement at 26-27.
    \193\ See FINRA Statement at 27.
    \194\ See FINRA Statement at 27.
---------------------------------------------------------------------------

    In response to Petitioners' comments that certain entities, such as 
pension funds and state agencies, may be unable to post margin, or that 
registered investment companies are not permitted to re-pledge 
collateral, FINRA stated that it disagrees, arguing that Petitioners do 
not explain why registered investment companies could not re-pledge 
collateral subject to appropriate custody arrangements.\195\ In 
addition, to the extent Petitioners assert that registered investment 
companies or pension plans cannot post margin, FINRA believes they are 
incorrect, stating that it believes that registered investment 
companies can post margin.\196\ FINRA stated that these entities are 
simply required to account for the obligation to post margin as part of 
their potential exposures with respect to derivative transactions, as a 
condition to their derivative obligations not being subject to more 
general restrictions on such companies' ability to incur debt.\197\ In 
addition, FINRA stated that it believed that, under a 2013 Advisory 
Opinion from the Department of Labor, ERISA pension plans can post both 
initial and variation margin, and the assets deposited with the 
counterparty ``to support payment obligations that may become necessary 
for the plan'' ``would not be plan assets for the purposes of Title I 
of ERISA.'' \198\ Finally, FINRA stated that, in any event, the 
proposed amendment that would permit FINRA members to substitute a 
capital charge for the collection of margin is intended to provide the 
very flexibility Petitioners seek to continue to deal with 
counterparties who are unable or unwilling to post margin, while 
maintaining the overall effectiveness of the rule.\199\
---------------------------------------------------------------------------

    \195\ See FINRA Statement at 27-28.
    \196\ See FINRA Statement at 28.
    \197\ See FINRA Statement at 28. Specifically, FINRA cites to a 
Commission release regarding the use of derivatives by registered 
investment companies and business development companies to argue 
that registered investment companies can post margin, but must 
account for the obligation to post margin as part of their potential 
exposures to derivatives transactions as a condition to their 
derivative obligations not being subject to more general 
restrictions on the ability to incur debt. See Use of Derivatives by 
Registered Investment Companies and Business Development Companies, 
Investment Company Act Release No. 34084 (Nov. 20, 2020), 85 FR 
83162, 83175 (Dec. 21, 2020) (File No. S7-24-15).
    \198\ See FINRA Statement at 28; Department of Labor Advisory 
Opinion 2013-01A (Feb. 7, 2013).
    \199\ See FINRA Statement at 28.
---------------------------------------------------------------------------

    In response to the comment that the proposed amendment will 
increase systemic risk or that FINRA failed to consider it, FINRA 
stated that systemic risk was one of the original reasons FINRA 
proposed the 2016 Amendments in the first place.\200\ Further, FINRA 
stated that the 2021 Amendments are part of an effort by FINRA to 
address a significant source of potential systemic risk, and risk to 
its members: the risk of exposure to counterparty defaults on the 
purchase of forward-settling Covered Agency Transactions during the 
often lengthy period between trade and settlement dates.\201\ In 
addition, FINRA stated that to the extent that certain market 
participants are no longer able to take on the same amount of risk that 
they were prior to the 2016 Amendments that will reduce systematic risk 
rather than increase it.\202\
---------------------------------------------------------------------------

    \200\ See FINRA Statement at 42.
    \201\ See FINRA Statement at 2, 5, 8.
    \202\ See FINRA Statement at 42. FINRA stated that unmargined 
positions in the TBA market could raise systemic concerns, because, 
if one or more counterparties defaulted, the interconnectedness and 
concentration in the TBA market may lead to potentially broadening 
losses and the possibility of substantial disruption to financial 
markets and participants. Id.
---------------------------------------------------------------------------

    In response to comments that the proposed rule change may result in 
higher capital or margin charges, FINRA stated that, in some of these 
scenarios, commenters attributed the higher margin or capital 
requirements to the fact that the transactions (termed ``non-netting'' 
by one commenter and ``non-nettable'' by another) will not net under 
the proposed rule change.\203\ According to FINRA, the only requirement 
to be able to net transactions in determining a counterparty's ``net 
mark to market loss'' is that the member have a legal right to offset 
losses on one transaction against gains on the other (or a security 
interest that would allow it to apply gains on one transaction to the 
counterparty's losses on the other).\204\
---------------------------------------------------------------------------

    \203\ See Amendment No. 1 (2021) at 7-8.
    \204\ See Amendment No. 1 (2021) at 7-8.
---------------------------------------------------------------------------

    FINRA acknowledged that the margin requirements and capital charges 
under

[[Page 50219]]

both the proposed rule change and the current rule are higher in 
certain scenarios (and lower in others) than they would be under a 
commenter's suggestion that (1) there should be no margin requirements 
applicable to Covered Agency Transactions (up to the second monthly 
SIFMA settlement date),\205\ and (2) members should be required to take 
capital charges for only ten percent of their counterparties' 
unmargined mark to market losses.\206\ FINRA stated that it believes 
that these suggestions would significantly undercut the objective of 
the rule to protect against the risk of unsecured credit exposure in 
Covered Agency Transactions.\207\ In addition, FINRA stated that the 
same factors that make smaller firms more sensitive to the margin 
requirements also make them more vulnerable to the risk of counterparty 
default, which such firms may be less able to absorb, underscoring the 
need for the margin requirement regime. Further, FINRA stated that the 
current rule, would, subject to specified exceptions, require members 
to collect margin whenever their counterparties' mark to market losses 
(and two percent maintenance margin deficiency, where applicable) 
exceeds $250,000, and would require them to take a capital charge to 
the extent such margin is not collected by the close of business on the 
business day after such mark to market loss (or maintenance margin 
deficiency) arose.\208\ FINRA stated that the proposed rule change 
preserves all of the exceptions in the current rule, eliminates the two 
percent maintenance margin requirement, and provides an option, subject 
to specified terms and conditions, to take capital charges in lieu of 
collecting margin for net mark to market losses in excess of 
$250,000.\209\ Because the proposed rule change eliminates the two 
percent maintenance margin requirement and related capital charges for 
uncollected maintenance margin, FINRA stated that the margin 
requirements and capital charges under the proposed rule change are 
less than the requirements under the current rule.\210\
---------------------------------------------------------------------------

    \205\ See section III.F.3. below for FINRA's responses to 
comments and the Commission's findings related to moving the margin 
collection date to a longer period.
    \206\ According to FINRA, under the current rule and the 
proposed rule change, members are not required to collect margin, or 
take capital charges in lieu of collecting margin, to cover the net 
mark to market losses of small cash counterparties, registered 
clearing agencies, Federal banking agencies (as defined in 12 U.S.C. 
1813(z)), central banks, multinational central banks, foreign 
sovereigns, multilateral development banks, or the Bank for 
International Settlements. FINRA stated that these exceptions mean 
that some members engaging in Covered Agency Transactions with these 
counterparties may have lower margin and capital requirements under 
the current rule and the proposed rule change than they would under 
the commenter's suggestion. See Amendment No. 1 (2021) at 9; FINRA 
Statement at 34.
    \207\ See Amendment No. 1 (2021) at 8-9; FINRA Statement at 34.
    \208\ See Amendment No. 1 (2021) at 8.
    \209\ See Amendment No. 1 (2021) at 8.
    \210\ See Amendment No. 1 (2021) at 8. The proposal to eliminate 
the two percent maintenance margin requirement is discussed in 
section III.A.1. above.
---------------------------------------------------------------------------

c. Commission Discussion and Findings
    In proposing to permit broker-dealers the option to take a capital 
charge in lieu of collecting the excess net mark to market loss from a 
counterparty, FINRA has reasonably balanced the goal of reducing the 
potential competitive impacts of the current rule on small and medium-
sized broker-dealers, while maintaining the objectives of the original 
rulemaking to reduce a broker-dealer's risk arising from unsecured 
credit exposures to Covered Agency Transactions, and to encourage the 
collection of margin. As an initial matter, this aspect of the proposal 
does not add any new requirements (including any new margin collection 
requirements); rather, it provides an additional option to broker-
dealers to comply with the rule's requirements. This option, therefore, 
should facilitate securities transactions in the Covered Agency 
Transaction market by providing additional flexibilities to broker-
dealers while continuing to protect investors and the public from 
potential losses arising from risks of unsecured exposures in the 
Covered Agency Transaction market.\211\
---------------------------------------------------------------------------

    \211\ For example, the option to take a capital charge also will 
give broker-dealers the flexibility to engage in Covered Agency 
Transactions with counterparties that may be prevented by contract 
or otherwise from posting margin to a broker-dealer.
---------------------------------------------------------------------------

    Further, the current rule includes a number of exceptions designed 
to alleviate the impact of the Covered Agency Transaction margin 
requirements on smaller firms and counterparties, including the small 
cash counterparty exception, an exception from collecting margin or 
taking a capital charge on the first $250,000 net mark to market loss 
from any counterparty, and the exclusion of multifamily housing 
securities and project loan program securities from the scope of the 
current rule.\212\ The proposal retains these exceptions in the current 
rule, and builds on them to provide even more flexibility to broker-
dealers, including small and medium-sized broker-dealers, through the 
narrow amendment to permit them the option to take a capital charge in 
lieu of collecting the excess net mark to market loss from a 
counterparty in a Covered Agency Transaction.\213\
---------------------------------------------------------------------------

    \212\ See 2016 Approval Order, 81 FR at 40375.
    \213\ For example, if a small broker-dealer has a counterparty 
that has $9 million in exposure to Covered Agency Transactions in 
their account, the counterparty would be excluded from the scope of 
the rule because they are a ``small cash counterparty,'' and the 
broker-dealer would not need to collect margin or take a capital 
charge with respect to this account. If the same counterparty's 
exposure to Covered Agency Transactions increased to $11 million, 
the broker-dealer would be required to collect margin or take a 
capital charge only when the net mark to market loss exceeded 
$250,000. The broker-dealer is not required to take a capital charge 
or collect the net market to market loss unless it exceeds $250,000 
(i.e., the excess net mark to market loss). When the amount of the 
net mark to market loss exceeds $250,000, the broker-dealer must 
collect the amount that exceeds $250,000 or take a capital charge, 
subject to the 25% TNC/$30MM Threshold. The small cash counterparty 
exception and the $250,000 mark to market loss exception also do not 
count toward the calculation of the 25% TNC/$30MM Threshold.
---------------------------------------------------------------------------

    The option to take a capital charge in lieu of collecting excess 
net mark to market margin will promote competition for smaller broker-
dealers in relation to regional banks not subject to margin 
requirements, and larger broker-dealers which may have more market 
power to obtain margin agreements and collect margin from their 
counterparties. The proposed rule reduces regulatory burden for broker-
dealers, including smaller broker-dealers, from the requirements under 
the current rule to collect margin from a counterparty where there is 
no exception, by providing broker-dealers the option to take a capital 
charge in lieu of collecting the excess net mark to market loss. This 
option will permit broker-dealers to attract or retain counterparties 
from whom they do not collect margin thereby allowing them to more 
effectively compete with regional banks and large broker-dealers, and 
to transact with counterparties that may not be able to--or who are 
unwilling to--post margin.\214\ The option to take a capital charge in 
lieu of collecting the

[[Page 50220]]

excess net mark to market loss from a counterparty directly responds to 
comments that counterparties will elect to transact with regional banks 
that are not subject to margin requirements and the proposal will cause 
smaller broker-dealers to exit the Covered Agency Transaction market or 
reduce their Covered Agency Transaction business.
---------------------------------------------------------------------------

    \214\ Petitioners suggested that certain counterparties cannot 
post margin. The proposed capital in lieu of margin charge is 
intended to provide broker-dealers flexibility in cases where the 
broker-dealer does not collect margin from a counterparty to a 
Covered Agency Transaction. Petitioners also stated that registered 
investment companies cannot re-pledge collateral without explaining 
why or how this would impact the ability of such entities to post 
margin. While posting margin may not be explicitly prohibited, the 
Commission notes that any entity that posts margin must do so in 
compliance with applicable law. For example, registered investment 
companies are subject to the provisions set forth in Sections 17(f) 
and 18 of the Investment Company Act of 1940 regarding custody and 
the issuance of senior securities, respectively, as well as the 
rules promulgated thereunder (e.g., Rule 18f-4, which addresses the 
use of derivatives by registered investment companies, among 
others).
---------------------------------------------------------------------------

    The option to take a capital charge in lieu of collecting the 
excess net mark to market loss from a counterparty will require a 
broker-dealer to set aside net capital to address the risks of 
unsecured credit exposures in the Covered Agency Transaction market 
that are mitigated through the collection of margin collateral. The net 
capital set aside will serve as an alternative to obtaining margin 
collateral for the purpose of reducing the risk of unsecured credit 
exposures to the broker-dealer, as well as potential losses in the 
event of a counterparty default. The proposed rule, therefore, should 
reduce the risk of loss to the broker-dealer, and enhance, rather than, 
deplete the liquidity of a broker-dealer. The requirement to collect 
margin or take a capital charge in lieu of collecting the excess mark 
to market loss from a counterparty also is consistent with other 
regulatory efforts that have sought to address the risk of 
uncollateralized exposures arising from different types of bilateral 
transactions with counterparties.\215\
---------------------------------------------------------------------------

    \215\ See, e.g., Exchange Act Rule 18a-3 (imposing margin 
requirements on non-cleared security-based swap transactions for 
security-based swap dealers and major security-based swap 
participants); FINRA Rule 4240 (prescribing margin requirements for 
non-cleared security-based swaps for FINRA member broker-dealers 
that are not registered as security-based swap dealers).
---------------------------------------------------------------------------

    Further, the Commission agrees with FINRA that the regulatory need 
for attention to this area is no less than when FINRA initiated the 
original rulemaking. For example, during March 2020, the prices of 
agency mortgage-backed securities declined and transaction costs (bid-
ask spreads) rose, leading to tightened liquidity in the agency 
mortgage-backed security repurchase agreement (or ``repo') market.\216\ 
These events highlight the need to reduce the risk of uncollateralized 
exposures in the Covered Agency Transaction market. Unsecured exposures 
in the Covered Agency Transaction market could raise systemic concerns, 
in that if one or more counterparty to a Covered Agency Transaction 
defaults, the interconnectedness and concentration in the Covered 
Agency Transaction market may lead to potentially broadening losses and 
the possibility of substantial disruption to financial markets and 
participants. Further, to the extent that certain market participants 
cannot increase their leverage through unsecured exposures because they 
must collect the excess net market to market loss from their 
counterparties in a Covered Agency Transaction, or take a capital 
charge, that will serve to reduce systemic risk rather than increase 
it. Consequently, while the proposed rule does not entirely alleviate 
the competitive burdens on smaller broker-dealers, the option to take a 
capital charge in lieu of collecting the excess net mark to market loss 
reduces competitive burdens in a measured way that retains the 
protections of the current rule to reduce the risk of unsecured credit 
exposures in the Covered Agency Transaction market without diminishing 
investor protection.\217\
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    \216\ See DERA Report at 69; See also Letter from Robert D. 
Broeksmit, CMB President and Chief Executive Officer, MBA to Robert 
W. Cook, Chief Executive Officer, FINRA and Jay Clayton, Chairman, 
Commission (Mar. 29, 2020) (attached as Appendix B to MBA Letter) 
(``MBA 2020 Letter'') (asking for flexibility in margin practices at 
broker-dealers during March 2020).
    \217\ The record also demonstrates that FINRA conducted an 
Economic Impact Assessment of the proposed rule change, including 
the anticipated competitive effects, the anticipated costs and 
benefits and alternatives considered. See Notice, 86 FR 28166-68.
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    The continued requirement to collect margin for the excess net mark 
to market losses or take a capital charge in lieu of collecting margin 
for the excess net mark to market losses also will remove the 
possibility that FINRA members will compete through the implementation 
of lower margin levels (or no margin requirements) for Covered Agency 
Transactions. As such, the proposed rule change will require consistent 
practices among FINRA member broker-dealers in terms of collecting 
margin for a Covered Agency Transaction or holding sufficient capital 
to serve as a risk-reducing alternative to collecting margin.
    With respect to the comments from small broker-dealers that raised 
concerns that they will need to rely almost exclusively on the capital 
in lieu of margin charges,\218\ as stated above, the proposal does not 
add any new requirements; rather, it provides an additional option to 
broker-dealers to comply with the rule's requirements through a capital 
charge. In addition, since the adoption of the current rule, broker-
dealers already have been adjusting to the Covered Agency Transaction 
margin requirements by negotiating and entering into margin agreements 
with their customers, which should permit them to collect margin when 
necessary, and reduce the likelihood of reaching the 25% TNC/$30MM 
Threshold.\219\ Further, the proposed rule change provides that a 
broker-dealer with non-margin counterparties must establish and enforce 
risk management procedures reasonably designed to ensure that the 
optional capital charges do not exceed $25 million, and promptly notify 
FINRA if the amount of specified net capital charges exceeds $25 
million for five consecutive business days. These additional risk 
management procedures for broker-dealers with non-margin counterparties 
under the proposed rule change should reduce the likelihood that a 
smaller broker-dealer will exceed the 25% TNC/$30MM TNC Threshold.
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    \218\ Smaller broker-dealers stated they must rely on the 
optional capital charge because they cannot or are not able to enter 
into margin agreements with customers.
    \219\ See Notice, 86 FR at 28167; MBA 2020 Letter; MBA Letter.
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    For some broker-dealers, their volume of business may reach the 25% 
TNC/$30MM Threshold where the broker-dealer cannot take further capital 
charges, and at that point, the 25% TNC/$30MM Threshold would then 
prevent the broker-dealer from entering into any new Covered Agency 
Transaction with a counterparty that is unable or unwilling to post 
margin. While the ability of a broker-dealer to inject liquidity into 
the Covered Agency Transaction market could potentially be reduced 
until it falls below the 25% TNC/$30MM Threshold, raising the threshold 
for permitted optional capital charges would undermine the 
effectiveness of the proposed rule change by increasing the broker-
dealer's uncollateralized exposures to Covered Agency Transactions, and 
thereby increase the risk of a counterparty's default. In summary, the 
option to take a capital charge in lieu of collecting margin, along 
with the exceptions in the current rule and the additional risk 
management procedures for non-margin counterparties should provide 
broker-dealers (including smaller broker-dealers) sufficient 
flexibilities to enable them to better compete in the Covered Agency 
Transaction market (including participating in the housing finance 
sector and providing access to liquidity for underserved communities), 
while encouraging them to collect margin from their 
counterparties.\220\
---------------------------------------------------------------------------

    \220\ See Notice 86 FR at 28164. In addition to broker-dealers, 
other market participants such as banks of all sizes may provide 
liquidity to the Covered Agency Transaction market.
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    The Commission agrees with FINRA that allowing firms to take a 100 
percent capital charge in lieu of collecting excess net mark to market 
loss without

[[Page 50221]]

the limitation of the 25% TNC/$30MM Threshold will exacerbate the 
competitive disparity between large and small broker-dealers. Because 
large broker-dealers will have a larger capital base than small broker-
dealers, the absence of a threshold would enable large broker-dealers 
to take more capital charges if they did not wish to collect margin 
from customers. Consequently, customers of small broker-dealers could 
opt to enter into transactions with larger broker-dealers instead of 
transacting with smaller broker-dealers in order to avoid posting 
margin, allowing larger broker-dealers to use their larger capital base 
to competitively disadvantage smaller broker-dealers.
    In addition, in response to a concern expressed in the Petition for 
Review,\221\ the Commission does not believe that the 25% TNC/$30MM 
Threshold will limit a large broker-dealer's ability to provide 
liquidity to the market in times of stress. As discussed above, larger 
broker-dealers have more market power to negotiate margin agreements 
with their counterparties and to collect margin (in contrast to smaller 
broker-dealers). Consequently, large broker-dealers generally should 
have the ability to collect the excess net mark to market loss from a 
counterparty rather than relying on the optional capital charges. 
Therefore, the 25% TNC/$30MM Threshold should not limit their ability 
to engage in Covered Agency Transactions in times of volatility and to 
provide liquidity to the market.\222\
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    \221\ See Petition for Review at 30.
    \222\ See Notice, 86 FR at 28162.
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    The Commission disagrees with commenters' statements that despite 
FINRA's efforts to mitigate the harms to smaller market participants 
and lessen the burdens the proposed rule change will impose on 
competition, these burdens remain significant, unnecessary and 
inappropriate. As described above, the only amendments to the current 
rule before the Commission under the proposed rule change, as modified 
by Amendment No. 1 (2021), are to eliminate the two percent maintenance 
margin requirement, permit capital in lieu of margin charges, and to 
reorganize and streamline the rule text. These proposed amendments 
build upon the already existing exceptions adopted in the 2016 
Amendments, which, as discussed above in this section III.A.2.c., are 
retained in the proposed rule. While the Commission appreciates the 
recommendations made by various commenters, and recognizes that the 
Amended Margin Collection Requirements may result in increased costs 
for some FINRA members and their counterparties, the Commission 
believes that FINRA responded appropriately to their concerns. Taking 
into consideration the comment letters, FINRA's responses to the 
comments, the Petition for Review, and the statements received in 
response to the Petition for Review, the Commission believes that the 
proposed rule change, as modified by Amendment No. 1 (2021), is 
consistent with the Exchange Act. In structuring the proposed rule 
change, as modified by Amendment No. 1 (2021), to allow for additional 
flexibilities with the option to take a capital charge in lieu of 
collecting the excess net mark to market loss, FINRA has reasonably 
balanced the goal of reducing unsecured credit exposures in the Covered 
Agency Transaction market and encouraging the collection of margin, 
with the potential costs and competitive impacts that may result from 
the proposed rule change.\223\ FINRA has stated it remains committed to 
ensuring that FINRA Rule 4210, as amended, in practice, does not 
disadvantage smaller broker-dealers who are most focused on community 
institutions, including those owned by women, minorities and 
veterans.\224\ Finally, the Commission believes that commenters other 
suggestions to exclude additional product types or counterparties from 
the rule, reduce required capital charges from 100 percent to 10 
percent, or extend the time periods under which broker-dealers must 
collect margin would significantly undermine the risk-reducing 
objective of the current rule and diminish investor protection.\225\
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    \223\ See section I.B. above (detailing the procedural history 
and background of Covered Agency Transaction margin requirements for 
the 2016 and 2021 Amendments).
    \224\ See FINRA Statement at 34.
    \225\ See section III.F.3. below (discussing other suggestions 
by commenters that would undermine the objectives of the rule to 
reduce the risk of unsecured credit exposures to Covered Agency 
Transactions and to encourage the collection of margin).
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    Overall, the Commission believes the flexibility created by the 
proposed rule change with the optional capital charge will further 
alleviate the competitive burdens on small broker-dealers, including 
women, minority and veteran-owned firms, compared to larger broker-
dealers and banks, while ensuring a broker-dealer collects margin or 
sets sufficient capital aside to cover the unsecured counterparty 
exposure in Covered Agency Transactions. The Commission believes that 
any limited competitive burdens placed on small broker-dealers are 
reasonable in light of the benefits the rule provides by strengthening 
the financial condition of the broker-dealer and addressing the risk of 
unsecured credit exposures in the Covered Agency Transaction market. 
Consequently, the Commission believes that the proposed rule change to 
permit broker-dealers to take a capital charge in lieu of collecting 
the excess net mark to market loss, which builds on the exceptions in 
the current rule to mitigate the impact of the proposed rule change on 
smaller broker-dealers, would further the purposes of the Exchange Act 
as it is reasonably designed to protect investors and the public 
interest.
3. Streamlining and Consolidation of Rule Language; Conforming 
Revisions
    As discussed above in section II.C., FINRA proposed several 
amendments designed to streamline and consolidate the rule language and 
make conforming revisions in support of the proposed amendments 
regarding the elimination of the two percent maintenance margin 
requirement, and the option to take a capital charge in lieu of 
collecting margin.\226\ For example, FINRA proposes to delete the 
Supplemental Material related to monitoring mortgage banker 
counterparties because they were treated as exempt accounts under the 
current rule. Because the proposed rule change does not distinguish 
between exempt and non-exempt accounts, this Supplemental Material is 
redundant and FINRA proposed to delete it.\227\
---------------------------------------------------------------------------

    \226\ See Notice, 86 FR at 28165-28166.
    \227\ See Notice, 86 FR at 28166.
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    The Commission did not receive comments on the proposed 
streamlining, consolidating and conforming amendments. The Commission 
believes the proposed rule change to streamline, consolidate, and 
conform the current rule text to reflect the proposed rule changes is 
appropriate in light of the elimination of the two percent maintenance 
margin requirement, and the addition of the optional capital in lieu of 
margin charge. The conforming amendments to the current rule will align 
the rule text to reflect the proposed rule changes and, in turn, create 
operational efficiencies and reduce costs for broker-dealers. For 
example, the proposed rule text clarified the language with respect to 
the $250,000 mark to market loss, thereby making it easier to determine 
the applicable margin amount.\228\ This is expected to reduce costs in 
determining the required margin when a broker-dealer establishes a 
trading relationship with a counterparty.
---------------------------------------------------------------------------

    \228\ See Notice, 86 FR at 28168.
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    Overall, the amendments to the proposed rule change, as modified by 
Amendment No. 1 (2021), to streamline, consolidate, and conform the 
rule text

[[Page 50222]]

language will promote efficiency for broker-dealers and facilitate 
trading in the Covered Agency Transaction market.

B. The 2021 Amendments Should Reduce Potential Liquidations and 
Counterparty and Dealer ``Chains'' of Fails

1. Comments Received on Proposal
    Commenters expressed concern about requirements to liquidate 
Covered Agency Transactions stating that market participants often 
engage in long ``chains'' of Specified Pool or CMO transactions, where 
the initial seller contracts to sell a Specified Pool or CMO to the 
initial buyer, the initial buyer contracts to sell the Specified Pool 
or CMO to a second buyer, who contracts to sell it to a third buyer, 
etc.\229\ The commenters stated that if any party in the chain (except 
for the last buyer) terminates its purchase or sale transaction, the 
buyer in the terminated transaction is unlikely to be able to buy the 
Specified Pool or CMO elsewhere, and therefore will be unable to 
perform on its sale transaction--and so will every subsequent buyer and 
seller in the chain. These commenters also stated that FINRA should 
eliminate or suspend the liquidation requirement under the proposed 
rule change to avoid the prospect of a ``daisy chain'' of fails.\230\
---------------------------------------------------------------------------

    \229\ See Brean Capital Letter at 12-13, 20; SIFMA Letter at 3.
    \230\ See Brean Capital Letter at 12-13; SIFMA Letter at 3.
---------------------------------------------------------------------------

    In the Petition for Review, Petitioners stated that they believe 
FINRA's responses failed to adequately address the substance of their 
objection that the proposed rule change creates a new and untenable 
counterparty risk, i.e., the risk that a transaction will fail because 
of a failure of another transaction elsewhere in a chain of 
transactions.\231\ Petitioners also believed the proposed rule change 
will result in counterparties posting margin on the same underlying 
security in a chain resulting in a drain on liquidity.\232\ Petitioners 
also reiterated their concerns that market participants will be 
reluctant to engage in Covered Agency Transactions if uncertainties 
exist as to whether FINRA will grant extensions of time related to 
liquidations, and under what standards FINRA uses to grant them.\233\ 
Petitioners also continued to raise concerns about the ability of a 
broker-dealer and a counterparty to resolve valuation disputes within 
five business days.\234\
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    \231\ See Petition for Review at 35-36.
    \232\ See Petition for Review at 37.
    \233\ See Petition for Review at 38.
    \234\ See Petition for Review at 38.
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2. FINRA's Response to Comments
    FINRA responded that, under the current rule, if a counterparty's 
unmargined net mark to market loss (and two percent maintenance margin 
deficiency, where applicable) exceeds $250,000 and is not margined or 
eliminated within five business days from the date it arises, the 
member is required to liquidate the counterparty's positions to satisfy 
the mark to market loss (and two percent maintenance margin deficiency, 
where applicable), unless FINRA specifically grants additional time. 
The proposed rule change eliminates this liquidation requirement.\235\
---------------------------------------------------------------------------

    \235\ See Amendment No. 1 (2021) at 9.
---------------------------------------------------------------------------

    In addition, FINRA stated that, under the proposed rule change, a 
member can opt to take a capital charge in lieu of collecting margin to 
cover a counterparty's excess net mark to market loss. FINRA stated 
that if these capital charges \236\ exceed the 25% TNC/$30MM Threshold 
for five consecutive business days, then the member:
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    \236\ As discussed in more detail in section II.B. above, FINRA 
stated that it is modifying the proposed rule change so that capital 
charges for a counterparty's unmargined excess net mark to market 
loss do not count toward the 25% TNC/$30MM Threshold to the extent 
that the member, in good faith, expects such excess net mark to 
market loss to be margined by the close of business on the fifth 
business day after it arose. See Amendment No. 1 (2021) at 10.
---------------------------------------------------------------------------

     May not enter into new Covered Agency Transactions with 
non-margin counterparties other than risk reducing transactions;
     Must, to the extent of its rights, promptly collect margin 
for each counterparty's excess net mark to market loss; and
     Must, to the extent of its rights, promptly liquidate the 
Covered Agency Transactions of any counterparty whose excess net mark 
to market loss is not margined or eliminated within five business days 
from the date it arises, unless FINRA has specifically granted the 
member additional time.\237\
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    \237\ See Amendment No. 1 (2021) at 10; FINRA Statement at 36.
---------------------------------------------------------------------------

    Moreover, FINRA stated that if the member does not have the right 
to liquidate a counterparty's Covered Agency Transactions, the proposed 
rule change does not require the member to liquidate those 
transactions, even after the member has exceeded the 25% TNC/$30MM 
Threshold for five business days.\238\ However, according to FINRA, if 
the member has exceeded the 25% TNC/$30MM Threshold for five business 
days and the member does have a right to liquidate a counterparty's 
Covered Agency Transactions and the counterparty's excess net mark to 
market loss has not been margined or eliminated within five business 
days, only then would a member be required to enforce its liquidation 
right or obtain an extension from FINRA.\239\
---------------------------------------------------------------------------

    \238\ FINRA stated that a member is not required to have a right 
to liquidate a counterparty's Covered Agency Transactions. However, 
if the member does not have that right, the counterparty would be a 
``non-margin counterparty,'' and paragraph (e)(2)(H)(ii)d.1. under 
the proposed rule change would require the member to establish and 
enforce risk management procedures reasonably designed to ensure 
that the member would not exceed either of the limits specified in 
paragraph (e)(2)(I)(i) of the rule as amended by the proposed rule 
change and that the member's capital charges in lieu of margin on 
Covered Agency Transactions for all accounts combined will not 
exceed $25 million. According to FINRA, these procedures would 
likely involve limitations on the extent of the member's business 
with its non-margin counterparties. FINRA stated that when a broker-
dealer's risk management procedures function as they are required to 
be designed, the member will rarely cross the 25% TNC/$30MM 
Threshold, much less exceed it for five consecutive business days. 
See Amendment No. 1 (2021) at 10.
    \239\ See Amendment No. 1 (2021) at 10; FINRA Statement at 36.
---------------------------------------------------------------------------

    FINRA has also stated that this limited liquidation obligation 
should not lead to a daisy chain of fails, except possibly in 
circumstances where a counterparty's unwillingness or inability to 
perform its undisputed obligations makes it equally likely that a daisy 
chain of fails will occur whether or not the member liquidates a 
transaction with the counterparty.\240\ According to FINRA, there are 
four categories of reasons why a counterparty would fail to margin its 
excess net mark to market loss by the fifth business day after it 
arises, and FINRA stated that it believes only one of them has any 
prospect of leading to a liquidation requirement under the proposed 
rule change:
---------------------------------------------------------------------------

    \240\ See Amendment No. 1 (2021) at 10-11; FINRA Statement at 
36.
---------------------------------------------------------------------------

     First Category--The counterparty is a non-margin 
counterparty, i.e., the counterparty may not have an obligation, under 
a written agreement or otherwise, to margin its excess net mark to 
market losses within five business days after they arise. In this case, 
the member would not have a right under a written agreement or 
otherwise to liquidate the counterparty's Covered Agency Transactions 
when excess net mark to market losses are not margined or eliminated 
within five business days after they arise, and so would have no 
obligation or right under the proposed rule change to liquidate the 
counterparty's Covered Agency Transactions.\241\
---------------------------------------------------------------------------

    \241\ See supra note 238 (stating that when a broker-dealer's 
risk management procedures function as they are required to be 
designed, the member will rarely cross the 25% TNC/$30MM Threshold, 
much less exceed it for five consecutive business days).

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[[Page 50223]]

     Second Category--An operational issue may cause the 
counterparty to fail to satisfy its obligation to margin its excess net 
mark to market losses. FINRA believes that five business days should be 
more than enough time to resolve any operational issue. However, in the 
event an extended operational issue, or series of operational issues, 
prevents a counterparty from providing margin for its excess net mark 
to market loss within five business days after it arises, a 14-day 
extension can be obtained from FINRA if the member has exceeded the 25% 
TNC/$30MM Threshold for five consecutive business days and would 
otherwise be under an obligation to enforce a right to liquidate the 
counterparty's Covered Agency Transactions. FINRA expects that an 
operational issue should not continue long enough to prevent a 
counterparty from satisfying its margin obligation past the expiration 
of a 14-day extension.\242\
---------------------------------------------------------------------------

    \242\ See Amendment No. 1 (2021) at 11.
---------------------------------------------------------------------------

     Third Category--There may be a disagreement over the 
amount of the counterparty's excess net mark to market loss, leading 
the counterparty to believe that it has satisfied its obligation to 
provide margin but the firm to believe that it has not. Commenters 
suggested that relatively unique assets, like Specified Pools and CMOs, 
are more likely to be the subject of valuation disputes. FINRA stated 
that five business days should be more than enough time to resolve any 
valuation dispute. Firms whose business involves a significant volume 
of transactions that are prone to valuation disputes should analyze 
whether their risk management procedures should require their contracts 
for such transactions to include or incorporate a procedure for the 
prompt resolution of valuation disputes.\243\ FINRA stated that if an 
extended valuation dispute leads a counterparty to fail to provide 
margin for its excess net mark to market loss within five business days 
after it arises, a 14-day extension can be obtained from FINRA if the 
member has exceeded the 25% TNC/$30MM Threshold for five consecutive 
business days and would otherwise be under an obligation to enforce a 
right to liquidate the counterparty's Covered Agency Transactions. 
FINRA stated that a margin valuation dispute should not continue past 
the expiration of a 14-day extension.\244\
---------------------------------------------------------------------------

    \243\ FINRA stated, by way of example, the current Credit 
Support Annex to the ISDA Master Agreement contains a provision 
under which the parties generally agree to resolve disputes over the 
valuation of over-the-counter (``OTC'') derivatives for margin 
purposes by seeking four actual quotations at mid-market from third 
parties and taking the average of those obtained. FINRA stated that 
the OTC derivatives documented under ISDA Master Agreements can be 
much more difficult to value than any Specified Pool or CMO 
transaction. See Amendment No. 1 (2021) at 11-12.
    \244\ See Amendment No. 1 (2021) at 11-12.
---------------------------------------------------------------------------

     Fourth Category--The counterparty may be unwilling or 
unable to satisfy an undisputed obligation to margin its excess net 
mark to market loss. FINRA believes that, when a counterparty is 
unwilling or unable to satisfy its undisputed margin obligations, there 
is also reason for significant doubt that the counterparty would be 
willing and able to satisfy its obligations to pay or deliver on the 
settlement date of the transaction. When facing such an unreliable 
counterparty, FINRA stated that it believes it is possible the daisy 
chain of fails may occur even if the member does not liquidate. FINRA 
further stated that the daisy chain of fails could be just as easily 
triggered by the counterparty's unwillingness or inability to perform 
its obligations as by the member's liquidation of its transaction.\245\
---------------------------------------------------------------------------

    \245\ See Amendment No. 1 (2021) at 12.
---------------------------------------------------------------------------

    According to FINRA, with regard to this fourth category, to the 
extent feasible, members should terminate transactions with such 
counterparties in order to protect themselves against further exposure. 
However, FINRA stated that if a member believes that it would not be 
feasible to terminate a transaction with such a counterparty, or that 
such termination would be unduly disruptive to the member's business or 
the market, extensions may be available from FINRA if the member has 
exceeded the 25% TNC/$30MM Threshold for five consecutive business days 
and the member would otherwise be under an obligation to enforce a 
right to liquidate the counterparty's Covered Agency Transactions.\246\
---------------------------------------------------------------------------

    \246\ FINRA stated that although an initial 14-day extension 
will be granted upon application citing the applicable 
circumstances, any application for a lengthy extension, or series of 
extensions, must describe the reason for the request and the 
member's plans for protecting itself (now and in the future) against 
the risk posed by a counterparty that has demonstrated itself to be 
unwilling or unable to perform its undisputed obligations. See 
Amendment No. 1 (2021) at 12.
---------------------------------------------------------------------------

    According to FINRA, as described above, in the first category, 
members have no liquidation obligation under the proposed rule change. 
In the second and third categories, FINRA believes that the reason why 
the counterparty has not margined its excess net mark to market loss 
should be eliminated before the five business day period has ended, and 
generally before the expiration of a 14-day extension from FINRA.\247\
---------------------------------------------------------------------------

    \247\ See Amendment No. 1 (2021) at 13.
---------------------------------------------------------------------------

    Further, in response to the Petition for Review, FINRA stated that 
Petitioners suggest that the requirement for multiple parties in a 
chain of Covered Agency Transaction to collect margin or take a capital 
charge is a flaw.\248\ FINRA, however, stated that the proposed rule is 
designed to protect FINRA members against the risk of counterparty 
default.\249\ In that context, FINRA stated that a given broker-dealer 
is not protected by the fact that another broker-dealer ``up the 
chain'' has already collected margin or taken a capital charge.\250\ 
Rather, that broker-dealer is exposed to the contractual obligation to 
buy the securities on the settlement date and the credit risk that its 
counterparty will default on such purchase.\251\ FINRA stated that 
these transactions are not riskless, and the requirement that each 
FINRA member manage that risk by collecting margin or taking a capital 
charge is necessary for the safeguards in the Covered Agency 
Transaction margin regime to work.\252\ Further, in response to the 
Petition for Review, FINRA stated that Petitioners overstate the risk 
of a daisy chain of fails.\253\ FINRA reiterated that it believes that 
the only reasonable circumstance in which liquidation would be required 
under the proposal is one in which the broker-dealer has a contractual 
right to liquidate the transaction and the counterparty is unwilling or 
unable to post collateral.\254\ FINRA stated that in these 
circumstances the risk of default is particularly acute, that it is 
prudent in those circumstances to require the member to liquidate the 
position, and that it is likely that there would be a ``daisy chain 
failure'' regardless of the liquidation requirement because the 
counterparty would likely be unable to pay or deliver on the Covered 
Agency Transaction's settlement date.\255\ FINRA stated that, on 
balance, the benefits of the margin requirement outweigh a risk that is 
only likely to manifest in a scenario that raises a high probability of 
the very type of default that the margin requirements are designed to 
protect against is a valid and reasonable conclusion. Finally, in 
response to the Petition for Review, FINRA stated that the proposed 25% 
TNC/$30MM

[[Page 50224]]

Threshold is intended to limit FINRA members' risk exposure, with the 
goal of ensuring that a counterparty default does not cause a firm to 
fail and therefore to be unable to meet its obligations to customers 
and counterparties.\256\
---------------------------------------------------------------------------

    \248\ See FINRA Statement at 42.
    \249\ See FINRA Statement at 42.
    \250\ See FINRA Statement at 42.
    \251\ See FINRA Statement at 42-43.
    \252\ See FINRA Statement at 43.
    \253\ See FINRA Statement at 36.
    \254\ See FINRA Statement at 36.
    \255\ See FINRA Statement at 36-37.
    \256\ See FINRA Statement at 37.
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3. Commission Discussion and Findings
    The Commission agrees with FINRA that the probability of a 
liquidation causing a chain of fails would most likely occur when a 
counterparty to a Covered Agency Transaction cannot or will not meet a 
margin call, and that such a counterparty would likely be in default at 
settlement regardless of any liquidation requirement. The proposed rule 
change will provide broker-dealers the flexibility to collect margin 
for the excess net mark to market loss from a counterparty to a Covered 
Agency Transaction or take a capital charge in lieu of collecting the 
margin, subject to specified terms and conditions. A broker-dealer that 
employs the capital charge option--because it does not require the 
counterparty to post margin--eliminates the potential risk of a ``daisy 
chain'' of fails arising from the broker-dealer needing to liquidate a 
position of the counterparty for failing to post required margin.
    Further, the current rule requires a broker-dealer to collect 
variation and/or maintenance margin from every counterparty unless 
there is an exception, and liquidate a Covered Agency Transaction after 
five business days if they fail to collect required margin. The 
proposed rule change eliminates this requirement and instead proposes a 
more limited requirement to liquidate a counterparty's position in 
cases where the member has the contractual right to liquidate a 
counterparty's Covered Agency Transactions. The elimination of the two 
percent maintenance margin requirement also will reduce margin posting 
requirements of counterparties and, therefore, reduce the likelihood 
that a counterparty will fail to provide required margin in a manner 
that triggers the liquidation requirement. Under the proposed rule 
change, the requirement to liquidate a transaction will be triggered 
if: (1) the counterparty or product is not subject to any exceptions 
(including the $250,000 mark to market exception); (2) the broker-
dealer has the contractual right to liquidate the transaction; (3) the 
25% TNC/$30MM Threshold has been exceeded for five business days; and 
(4) FINRA has not granted any extensions. Thus, the liquidation 
requirement generally will be triggered in limited circumstances and, 
as discussed above, when those circumstances arise it is likely that 
the chain of fails would occur irrespective of the liquidation 
requirement.
    With respect to concerns regarding whether FINRA will grant 
extension requests related to liquidations (if a broker-dealer has a 
right to liquidate a transaction and has exceeded the 25%/$30MM 
Threshold for five business days), including cases where there is a 
valuation dispute,\257\ FINRA has indicated that an initial 14-day 
extension will be granted upon an application that describes the 
reasons for the extension request.\258\ FINRA also has previously 
addressed these concerns in its Frequently Asked Questions and Guidance 
for Covered Agency Transactions under Rule 4210 (``FAQs'') issued for 
the current rule.\259\ The ability to receive extensions of time beyond 
the five business day period will help to protect broker-dealers where 
liquidation is infeasible or would unduly disrupt the FINRA member's 
business or the markets.\260\ These extension procedures are consistent 
with longstanding practice and guidance for margin extensions under 
Rule 4210.
---------------------------------------------------------------------------

    \257\ One way to reduce the potential risks arising from 
valuation disputes is for a broker-dealer to incorporate procedures 
for resolving valuation disputes in margin agreements with 
counterparties. See Amendment No. 1 (2021) at 11-12.
    \258\ Any application for a lengthy extension, or series of 
extensions, must describe the reason for the request and the 
member's plans for protecting itself (now and in the future) against 
the risk posed by a counterparty that has demonstrated itself to be 
unwilling or unable to perform its undisputed obligations. See supra 
note 246.
    \259\ These FAQs (Frequently Asked Questions & Guidance: Covered 
Agency Transactions Under FINRA Rule 4210) are available at 
www.finra.org. FINRA has stated that the FAQs will be updated 
following approval of the proposed rule change. See section III.D.8. 
below. The electronic system to request extensions of time is 
FINRA's Regulatory Extension system or REX system. FINRA has 
previously indicated in its FAQs that it will update the REX system 
to accommodate broker-dealers' requests for extensions of time 
related to Covered Agency Transactions, and that it will announce an 
online education tool on how to use the REX system for extension 
requests in connection with such transactions. See, e.g., FINRA FAQs 
8 through 10.
    \260\ See Amendment No. 1 (2021) at 12-13.
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C. FINRA has Appropriately Responded to the Comments Regarding 
Introducing and Clearing Firm Matters

1. Comments Received on Proposal
    Commenters stated the proposed rule change does not address the 
role of clearing firms or reflect that FINRA has considered the actual 
way in which introducing brokers clear trades in Covered Agency 
Transactions.\261\ One commenter expressed concern about the costs of 
implementing the proposed rule change and stated the rule would be 
difficult to administer without the direct participation and support of 
clearing firms.\262\ Another commenter suggested that FINRA continue to 
facilitate dialogue among introducing and clearing firms.\263\
---------------------------------------------------------------------------

    \261\ See Brean Capital Letter at 13. For example, commenters 
stated that many regional broker-dealers cannot receive margin even 
if a customer posts it with a clearing firm, since the proposal does 
not provide a mechanism by which an introducing broker will receive 
a credit for collecting margin if the customer deposits the margin 
with the clearing broker. See BDA and Brean Capital Letter at 35-36; 
Petition for Review at 39; BDA Small Firms Letter at 2.
    \262\ See Stephens Letter at 3.
    \263\ See SIFMA Letter at 3.
---------------------------------------------------------------------------

    Further, introducing broker-dealers stated that the proposed 
amendments could result in requirements for firms to post margin to 
clearing firms under a contractual arrangement, in addition to taking 
capital charges because they do not or cannot enter into margin 
agreements with their counterparties. They stated that this scenario 
would double the financial obligations to these firms with respect to 
Covered Agency Transactions.\264\
---------------------------------------------------------------------------

    \264\ See Duncan-Williams/SouthState Letter at 3; Petition for 
Review at 34; BDA Small Firms Letter at 3.
---------------------------------------------------------------------------

    Further, in response to the 2022 Approval Order, Petitioners stated 
that neither FINRA nor the Division staff analyzed how FINRA's margin 
requirements would interact with the contractual requirements that 
clearing firms impose, and stated that they believe an after-the-fact 
promise to fix a problem with the original rulemaking is not an 
argument for approving the proposed rule change.\265\ The Petitioners 
stated that Amendment No. 1 (2021) to the proposed rule change did not 
reference any data supporting that collateral a clearing firm currently 
collects is insufficient to protect against the risk the proposed rule 
change seeks to address.\266\
---------------------------------------------------------------------------

    \265\ See Petition for Review at 34-35.
    \266\ See Petition for Review at 39.
---------------------------------------------------------------------------

2. FINRA's Response to Comments
    FINRA responded to the comments regarding clearing firms by stating 
that it has conducted extensive dialogue with introducing and clearing 
firms regarding the requirements of the current rule and the proposed 
rule change in the context of introducing and clearing arrangements, 
and such dialogue informed several of the proposed rule change's 
clarifying changes to the original rulemaking.\267\

[[Page 50225]]

Further, FINRA stated that it intends to continue to facilitate 
discussions with introducing and clearing firms as it implements the 
proposed rule change.\268\
---------------------------------------------------------------------------

    \267\ See Amendment No. 1 (2021) at 20.
    \268\ See Amendment No. 1 (2021) at 20.
---------------------------------------------------------------------------

    In addition, FINRA stated, in response to the comment in the 
Petition for Review that it failed to account for the fact that 
clearing firms already collect margin for Covered Agency Transactions 
from introducing firms, that this comment undermines the Petitioners' 
arguments that margining Covered Agency Transactions is 
unnecessary.\269\
---------------------------------------------------------------------------

    \269\ See FINRA Statement at 39.
---------------------------------------------------------------------------

3. Commission Discussion and Findings
    The fact that a clearing firm collects margin for Covered Agency 
Transactions from its introducing firms under a contractual agreement 
highlights the importance of protecting broker-dealers against the risk 
of unsecured credit exposures in the Covered Agency Transaction market 
through the collection of margin or capital charges. The proposed rule 
provides broker-dealers with the flexibility to take a capital charge 
in lieu of collecting the excess net mark to market loss from a 
counterparty; it is does not prescribe any new margin collection 
requirements. Where it chooses to collect margin, a broker-dealer would 
collect margin from its counterparty consistent with other margin 
requirements in FINRA Rule 4210. The proposed rule change, consistent 
with other Rule 4210 requirements, does not address the margin or other 
contractual requirements that a clearing firm may impose on its 
introducing firms, or the requirements that such firms must comply with 
under current FINRA rules. For example, FINRA Rule 4311 governs 
carrying and clearing firm arrangements, including allocations of 
responsibility with respect to extensions of credit.\270\
---------------------------------------------------------------------------

    \270\ See FINRA Rule 4311 and Covered Agency Transactions FAQs 
at www.finra.org.
---------------------------------------------------------------------------

    Finally, FINRA's response is appropriate that it will continue to 
engage in dialogue with introducing firms and clearing firms in 
implementing the proposed rule change.\271\ This is consistent with 
other proposed rule changes where FINRA answered questions or provided 
further guidance to market participants regarding implementation of new 
rules.\272\
---------------------------------------------------------------------------

    \271\ See, e.g., section III.D.8. below (discussing FAQs).
    \272\ See, e.g., FINRA Rules & Guidance/Interpreting the Rules, 
available at: https://www.finra.org/rules-guidance/interpreting-rules.
---------------------------------------------------------------------------

D. FINRA's Reponses to Other Comments, Requests for Clarifications; and 
Technical Revisions to the Proposed Rule Change are Appropriate and 
Consistent With the Exchange Act

    In response to the Notice and the 2021 Order Instituting 
Proceedings commenters raised additional matters regarding other 
aspects of the proposed rule change or requested clarifications or 
technical revisions to the proposed rule change, as modified by 
Amendment No. 1 (2021). These comments, FINRA's response to comments, 
and the Commission's discussion and findings are set forth below.
1. Definition of ``Net Mark to Market Loss'' and Use of Phrase 
``Legally Enforceable Netting Agreement'' in the Definition of ``Net 
Mark to Market Loss''
    A commenter requested confirmation that the definition of ``net 
mark to market loss'' would include the calculations utilized under the 
MSFTA form SIFMA publishes.\273\ In addition, Petitioners requested 
that FINRA identify which party is responsible for marking securities 
to market.\274\ In response, FINRA stated that it does not require or 
endorse any particular form of agreement for margining Covered Agency 
Transactions, and as such, declines to provide the requested 
confirmation because it relates to a commercial matter between the 
parties.\275\
---------------------------------------------------------------------------

    \273\ See SIFMA Letter at 4.
    \274\ See Petition for Review at 38-39; Stephens Letter at 2-3 
(stating that larger firms have an advantage in dictating the terms 
when determining the price in calculating margin).
    \275\ See Amendment No. 1 (2021) at 14. Similarly, FINRA stated 
that it also declines a commenter's request to confirm that an MSFTA 
with a cure period (or similar provision after the expiration of 
which liquidating action may be taken) of less than or equal to five 
business days would provide the rights described in the definition 
of ``non-margin counterparty'' under paragraph (e)(2)(H)(i)e. under 
the proposed rule change. See Amendment No. 1 (2021) at 14 and SIFMA 
AMG Letter at 4.
---------------------------------------------------------------------------

    A commenter also suggested that FINRA should remove the phrase 
``legally enforceable right of offset or security'' from the definition 
of ``net mark to market loss.'' \276\ In response to this suggestion, 
FINRA stated that this phrase is necessary.\277\ FINRA stated that, if 
the phrase is removed, then the amount of the counterparty's mark to 
market losses which are subject to margining would be reduced by the 
counterparty's mark to market gains on other transactions, without 
regard to whether the member has any legally enforceable right to apply 
those gains to cover the counterparty's losses. FINRA stated, for 
example, that if a counterparty defaults when it has a mark to market 
loss of $10 million on one transaction, and a mark to market gain of 
$10 million on another transaction, having a legally enforceable right 
of offset would allow the member to apply the counterparty's gains to 
cover its losses. In the absence of a legally enforceable right of 
offset or security, however, FINRA stated that the member could have an 
obligation to pay the counterparty $10 million for its gains, without 
any guaranty of collecting the full amount of the counterparty's $10 
million loss. If the counterparty enters insolvency proceedings, the 
lack of a legally enforceable right of offset or security could result 
in the member being obliged to pay the full $10 million of the 
defaulted counterparty's gains and only collecting cents on the dollar 
for the counterparty's losses.\278\
---------------------------------------------------------------------------

    \276\ See SIFMA Letter at 4.
    \277\ See Amendment No. 1 (2021) at 14.
    \278\ See Amendment No. 1 (2021) at 14.
---------------------------------------------------------------------------

    In addition, one commenter requested confirmation that the phrase 
``first-priority perfected security interest'' applies only to pledges 
of Covered Agency Transactions with third parties rather than to margin 
cash or securities posted to the broker-dealer.\279\ In response, FINRA 
stated that the phrase ``first-priority perfected security interest'' 
in paragraph (e)(2)(H)(i)d.2. under the proposed rule change only 
applies to pledges of a counterparty's rights under Covered Agency 
Transactions with third parties.\280\
---------------------------------------------------------------------------

    \279\ See SIFMA Letter at 4.
    \280\ See Amendment No. 1 (2021) at 14-15.
---------------------------------------------------------------------------

    In response to the comments about SIFMA's MSFTA form, the 
Commission agrees that FINRA appropriately responded that the proposed 
rule change does not require any specific form, agreement, or contract 
for margining Covered Agency Transactions. Each FINRA member and its 
counterparty may agree to use a particular form or agreement. This 
practice is consistent with other provisions of Rule 4210 that do not 
specify which party is responsible for calculating the mark to market 
gain or loss.
    Further, the Commission agrees with FINRA that retaining the phrase 
``legally enforceable right of offset or security'' in the definition 
of net mark to market loss is appropriate because it will allow a FINRA 
member to apply the counterparty's gains to cover its losses

[[Page 50226]]

only when there is a legally enforceable right to do so, which will 
reduce a broker-dealer's financial exposure to a counterparty in the 
event of insolvency. This will provide more certainty as to which 
transactions are nettable in the event of a counterparty's insolvency. 
If broker-dealers were permitted to net transactions from different 
counterparties where there is no legal right to do so, it would 
increase the risk under the proposed rule change that the broker-dealer 
would be exposed to additional losses in the event of a counterparty 
default. This result would undermine the effectiveness of the proposed 
rule change to reduce the risk of unsecured exposures in the Covered 
Agency Transaction market. Finally, FINRA's clarification with respect 
to the phrase ``first-priority perfected security interest'' is 
appropriate because FINRA clarified that it only applies to pledges of 
a counterparty's rights under Covered Agency Transactions with third 
parties. This clarification will assist broker-dealers and their 
counterparties in complying with the amendments under the proposed rule 
change.
2. Definition of ``Excess Net Mark to Market Loss''
    Some commenters requested confirmation from FINRA that broker-
dealers would only be required to collect the excess net mark to market 
loss (or take capital charges for such amount subject to specified 
terms and conditions) to cover the amount by which a counterparty's net 
mark to market loss exceeds $250,000.\281\
---------------------------------------------------------------------------

    \281\ See SIFMA Letter at 4; SIFMA AMG Letter at 4.
---------------------------------------------------------------------------

    In response to this request for confirmation, FINRA stated that the 
commenters are correct. According to FINRA, under the proposed rule 
change, paragraph (e)(2)(H)(ii)c. of FINRA Rule 4210 states the rule 
does not require members ``to collect margin, or take capital charges, 
for counterparties' mark to market losses on Covered Agency 
Transactions other than excess net mark to market losses'' and a 
counterparty's ``excess net mark to market losses'' are defined in 
paragraph (e)(2)(H)(i)c. as ``such counterparty's net mark to market 
loss to the extent it exceeds $250,000.'' \282\ FINRA stated that, for 
example, if a member's counterparty has a net mark to market loss of 
$300,000, its excess net mark to market loss is $50,000, which would be 
the amount of margin the proposed rule change would require the member 
to collect, or take a capital charge in lieu of collecting (unless 
there is an applicable exemption). FINRA stated that the counterparty's 
excess net mark to market loss is the minimum amount of margin that 
(subject to the exceptions) the member must collect (or take a capital 
charge in lieu of collecting). FINRA also stated that the proposed rule 
change does not prevent members and their counterparties from agreeing 
that the counterparty will transfer additional margin.\283\
---------------------------------------------------------------------------

    \282\ See Amendment No. 1 at 13.
    \283\ See Amendment No. 1 (2021) at 13-14.
---------------------------------------------------------------------------

    One commenter requested that FINRA clarify that broker-dealers may 
elect to treat the $250,000 as a minimum transfer amount (and collect 
the entire market to market loss once it exceeds $250,000), rather than 
a threshold below which the first $250,000 of the mark to market loss 
does not need to be collected.\284\ In response to this comment, FINRA 
stated that if a member has a right under a written agreement to 
collect margin for a counterparty's entire net mark to market loss 
whenever the amount of that loss exceeds $250,000, for purposes of the 
proposed rule change, it would view this as a right under a written 
agreement to collect margin for such counterparty's excess net mark to 
market loss, since the counterparty's excess net mark to market loss is 
$250,000 less than the counterparty's entire net mark to market loss 
(or zero if the net mark to market loss does not exceed $250,000).\285\
---------------------------------------------------------------------------

    \284\ See SIFMA AMG Letter at 4.
    \285\ See Amendment No. 1 (2021) at 15.
---------------------------------------------------------------------------

    FINRA's responses are consistent with the definition of ``excess 
net mark to market loss'' in the proposed rule change, i.e., that 
broker-dealers must collect the margin amount in excess of $250,000 or 
take a capital charge in lieu of collecting the excess net mark to the 
market loss. Further, broker-dealers also may agree with a counterparty 
to collect margin above the rule's requirements (i.e., collect the 
first $250,000 of the mark to market loss and treat the amount as a 
minimum transfer amount), which will further protect the broker-dealer 
from counterparty credit risk.
3. Definition of ``Non-Margin Counterparty''
    Under the proposed rule change, with respect to the five business 
day period, paragraph (e)(2)(h)(i)e.1. of FINRA Rule 4210 provides in 
part that a counterparty is a non-margin counterparty if the member 
``does not have a right under a written agreement or otherwise to 
collect margin for such counterparty's excess net mark to market loss 
and to liquidate such counterparty's Covered Agency Transactions if any 
such excess net mark to market loss is not margined or eliminated 
within five business days from the date it arises.'' \286\ A commenter 
stated that this proposed rule text effectively requires imposing a 
margin collection timing which is stricter than required under other 
rules or the standard under paragraph (f)(6) of FINRA Rule 4210.\287\
---------------------------------------------------------------------------

    \286\ See Amendment No. 1 (2021) at 15.
    \287\ See SIFMA Letter at 4.
---------------------------------------------------------------------------

    In response to this comment, FINRA stated that it disagrees for 
several reasons. First, FINRA stated that current rule requires a 
broker-dealer to liquidate positions whenever a mark to market loss (or 
maintenance deficiency) on Covered Agency Transactions is not margined 
or otherwise eliminated within five business days (and no extension has 
been obtained).\288\ FINRA stated that the proposed rule change uses a 
five business-day period but applies it more flexibly than under the 
current rule.\289\
---------------------------------------------------------------------------

    \288\ See Amendment No. 1 (2021) at 15.
    \289\ See Amendment No. 1 (2021) at 15.
---------------------------------------------------------------------------

    FINRA stated that if a member does not have a right under a written 
agreement or otherwise to collect margin for such counterparty's excess 
net mark to market loss and to liquidate such counterparty's Covered 
Agency Transactions if any such excess net mark to market loss is not 
margined or eliminated within five business days from the date it 
arises, that counterparty is a ``non-margin counterparty.'' \290\ As 
consequence, the member must take capital charges in cases where it is 
not collecting margin for a non-margin counterparty, and the member 
would become subject to the enhanced risk management requirements under 
the rule which requires firms with non-margin counterparties to 
establish and enforce risk management procedures reasonably designed to 
ensure that the capital charges in lieu of collecting margin do not 
exceed $25 million, and promptly notify FINRA if the amount of 
specified net capital charges exceeds $25 million for five consecutive 
business days.\291\ FINRA stated that the proposed rule also requires 
that if the member's specified net capital deductions exceed the 25% 
TNC/$30MM Threshold for five consecutive business days, the member 
would not be able to enter into transactions with a non-margin 
counterparty, other than risk reducing transactions, while those net 
capital deductions continue to exceed the threshold.\292\ FINRA stated 
that if the member has a right to

[[Page 50227]]

liquidate a counterparty's Covered Agency Transactions if the 
counterparty's excess net mark to market loss is not margined or 
eliminated within five business days, the member is not required to 
enforce that right (that is, not required to liquidate the 
counterparty's Covered Agency Transactions), unless and until the 
member's specified net capital deductions exceed the 25% TNC/$30MM 
Threshold for five consecutive business days (and the member has not 
obtained an extension from FINRA).\293\
---------------------------------------------------------------------------

    \290\ See Amendment No. 1 (2021) at 15.
    \291\ See Amendment No. 1 (2021) at 15-16.
    \292\ See Amendment No. 1 (2021) at 16.
    \293\ See Amendment No. 1 (2021) at 16. Further, FINRA stated 
that classification of a counterparty as a non-margin counterparty 
depends on (a) whether the member has the right to collect margin 
for the counterparty's excess net mark to market loss, (b) whether 
the member regularly collects margin for the counterparty's excess 
net mark to market loss, and (c) whether the member has the right to 
liquidate such counterparty's Covered Agency Transactions if the 
counterparty's excess net mark to market loss is not margined or 
eliminated within five business days from the date it arises. 
According to FINRA, classification of a counterparty as a margin 
counterparty (that is, as not a non-margin counterparty) does not 
require the member to exercise the right to liquidate whenever that 
counterparty's excess net mark to market loss is not margined or 
eliminate within five business days. However, FINRA stated that the 
counterparty would need to be reclassified as a non-margin 
counterparty if the member does not regularly collect margin for the 
counterparty's excess net mark to market loss. FINRA stated that the 
exercise of the right to liquidate is only required by the proposed 
rule change if the member's capital charges have exceeded the 25% 
TNC/$30MM Threshold for five consecutive business days (and the 
member has not obtained an extension from FINRA). See Amendment No. 
1 (2021) at 16 and SIFMA Letter at 4-5.
---------------------------------------------------------------------------

    Second, FINRA stated that even if members were required to have a 
contractual right to liquidate when margin is not collected within five 
business days, that would not, in the commenter's terms, ``impos[e] a 
margin collection timing that is stricter than that which is required 
under the rules (or other aspects of FINRA Rule 4210 generally)'' 
because paragraph (f)(6) of FINRA Rule 4210 requires margin to be 
collected ``as promptly as possible,'' and the rule as approved 
pursuant to the original rulemaking (as stated above) requires 
liquidation when a mark to market or maintenance deficiency has not 
been margined or eliminated within five business days (unless an 
extension has been obtained).\294\
---------------------------------------------------------------------------

    \294\ See Amendment No. 1 (2021) at 16-17.
---------------------------------------------------------------------------

    The Commission agrees with FINRA's response to the comment that the 
reference to a five business-day requirement in the definition of non-
margin counterparty effectively imposes a margin collection-timing 
requirement that is stricter than under current margin rules. A 
counterparty is a non-margin counterparty under the proposed rule 
change if the broker-dealer does not have a right under a written 
agreement or otherwise to collect margin for such counterparty's excess 
net mark to market loss and to liquidate such counterparty's Covered 
Agency Transactions if any such excess net mark to market loss is not 
margined or eliminated within five business days from the date it 
arises. The five business day reference in the definition of non-margin 
counterparty is used to classify counterparties as non-margin 
counterparties for purpose of the proposed rule change. The reference 
does not impose a five-day margin collection requirement. Therefore, it 
does not impose a margin requirement stricter than under current rules.
    Further, the current rule contains a liquidation requirement if a 
mark to market loss (or maintenance deficiency) on Covered Agency 
Transactions is not margined or otherwise eliminated within five 
business days (and no extension has been obtained). The proposed rule 
eliminates this requirement and permits greater flexibility with 
respect to whether a broker-dealer must liquidate a counterparty's 
positions if it has a right to do so (i.e., only after certain 
conditions occur and if no extensions of time have been obtained). 
Therefore, the reference to five business days in the term non-margin 
counterparty in the proposed rule changes does not effectively impose a 
margin collection or liquidation requirement whenever that 
counterparty's excess net mark to market loss is not margined or 
eliminated within five business days.
4. Exclusion of Exempted Counterparties From Definition of Non-Margin 
Counterparty
    A commenter suggested that FINRA explicitly exclude small cash 
counterparties and other exempted counterparties covered by paragraph 
(e)(2)(H)(ii)a.1. of FINRA Rule 4210 under the proposed rule change 
from the definition of ``non- margin counterparty.'' \295\ FINRA stated 
that this request is consistent with the purpose of paragraph 
(e)(2)(H)(ii)a.1. and has modified the definition of ``non-margin 
counterparty'' to implement the requested exclusion.\296\
---------------------------------------------------------------------------

    \295\ See SIFMA Letter at 5.
    \296\ See Amendment No. 1 (2021) at 17; Exhibit 4 to Amendment 
No. 1 (2021).
---------------------------------------------------------------------------

    The Commission agrees with FINRA that the modification of the 
definition of ``non-margin counterparty'' to exclude small cash 
counterparties and certain other counterparties from the scope of the 
rule, except with respect to the written risk limit determinations, is 
appropriate as it alerts broker-dealers subject to the rule that small 
cash counterparties and other exempted counterparties are specifically 
excluded from the definition and therefore do not count toward the 25% 
TNC/$30MM Threshold.
5. Computation of the 25% TNC/$30MM Threshold
    A commenter requested confirmation that margin not collected from 
small cash counterparties does not count toward the 25% TNC/$30MM 
Threshold.\297\ In response to this comment, FINRA stated that margin 
not collected from small cash counterparties does not count toward the 
25% TNC/$30MM Threshold.\298\ Further, FINRA stated that paragraph 
(e)(2)(H)(ii)d.3. of FINRA Rule 4210 only counts capital charges under 
paragraph (e)(2)(H)(ii)d.1. toward the 25% TNC/$30MM Threshold. In 
addition, FINRA stated that, under the proposed rule change, paragraph 
(e)(2)(H)(ii)a.1. of FINRA Rule 4210 does not require members ``to 
collect margin, or to take capital charges in lieu of collecting such 
margin, for a counterparty's excess net mark to market loss if such 
counterparty is a small cash counterparty, registered clearing agency, 
Federal banking agency, as defined in 12 U.S.C. 1813(z), central bank, 
multinational central bank, foreign sovereign, multilateral development 
bank, or the Bank for International Settlements.'' FINRA stated that 
because the proposed rule change does not require members to take 
capital charges for these counterparties' unmargined excess net mark to 
market losses, they do not count toward the 25% TNC/$30MM 
Threshold.\299\
---------------------------------------------------------------------------

    \297\ See SIFMA Letter at 5.
    \298\ See Amendment No. 1 (2021) at 17.
    \299\ See Amendment No. 1 (2021) at 17.
---------------------------------------------------------------------------

    The Commission agrees with FINRA's response to the commenter's 
request for confirmation regarding whether margin not collected from 
small cash counterparties counts toward the 25% TNC/$30MM Threshold. 
FINRA's response appropriately addresses the commenter's concerns and 
it reflects the plain language of the proposed rule change. Finally, 
while small cash counterparties do not count toward the 25% TNC/$30MM 
Threshold, the proposed rule prescribes additional protection through 
overall concentration thresholds under paragraph (e)(2)(I) of FINRA 
Rule 4210.\300\
---------------------------------------------------------------------------

    \300\ See section II.B. above (discussing paragraph (e)(2)(I) of 
FINRA Rule 4210 under the proposed rule change).
---------------------------------------------------------------------------

    With respect to counterparties yet to post margin, a commenter 
suggested

[[Page 50228]]

that the proposed rule change be modified so that any capital charge 
under paragraph (e)(2)(H)(ii)d.1. of FINRA Rule 4210 not count toward 
the 25% TNC/$30MM Threshold until the fifth business day after the 
relevant excess net mark to market loss arose.\301\ The commenter 
stated that many counterparties that are regularly margined are unable 
to post margin on a consistent T+1 basis due, for example, to those 
counterparties being in an overseas jurisdiction, or to operational or 
custodial issues.\302\ Moreover, the commenter stated good faith 
disputes over the amount of margin to be posted may mean that a 
counterparty does not post margin by T+1 even when the counterparty is 
ready, willing, and able to post margin promptly after the proper 
amount is determined.\303\ Finally, the commenter stated that, without 
a grace period, members may continuously exceed the 25% TNC/$30MM 
Threshold based on ordinary levels of margin not yet collected from 
counterparties who are expected to post required margin.\304\
---------------------------------------------------------------------------

    \301\ See SIFMA Letter at 6. The proposed rule would require a 
capital charge whenever a counterparty's excess net mark to market 
loss is not margined or eliminated by the close of business on the 
business day after the business day on which it arises. See proposed 
paragraph (e)(2)(H)(ii)d.1. in Exhibit 5 to the proposal.
    \302\ See SIFMA Letter at 5.
    \303\ See SIFMA Letter at 5.
    \304\ See SIFMA Letter at 5-6.
---------------------------------------------------------------------------

    In response to this comment, FINRA stated that the proposed rule 
change does not require counting toward the 25% TNC/$30MM Threshold 
capital charges taken for excess net mark to market losses that the 
member in good faith expects to be margined by the fifth business day 
after they arise.\305\ Accordingly, FINRA proposed to revise paragraph 
(e)(2)(H)(ii)d.3. of FINRA Rule 4210 so that capital charges under 
paragraph (e)(2)(H)(ii)d.1. with respect to a counterparty's unmargined 
excess net mark to market loss do not count towards the thresholds in 
paragraph (e)(2)(H)(ii)d.3. to the extent that the member, in good 
faith, expects such unmargined excess net mark to market losses to be 
margined within five business days.\306\ According to FINRA, members 
would still be required to protect themselves by taking net capital 
deductions while the excess net mark to market losses are unmargined, 
but, under the proposed rule change, as modified by Amendment No. 1 
(2021), will have more flexibility to address operational issues and 
valuation disputes before they impact the 25% TNC/$30MM Threshold.\307\
---------------------------------------------------------------------------

    \305\ See Amendment No. 1 (2021) at 18.
    \306\ See Amendment No. 1 (2021) at 18. More specifically, FINRA 
has revised paragraph (e)(2)(H)(ii)d.3. of FINRA Rule 4210 to refer 
to a member's ``specified net capital deductions'' (rather than to 
all net capital deductions under paragraph (e)(2)(H)(ii)d.1.) and 
inserted the following definition into paragraph (e)(2)(H)(i): i. A 
member's ``specified net capital deductions'' are the net capital 
deductions required by paragraph (e)(2)(H)(ii)d.1. of this Rule with 
respect to all unmargined excess net mark to market losses of its 
counterparties, except to the extent that the member, in good faith, 
expects such excess net mark to market losses to be margined by the 
close of business on the fifth business day after they arose. Id.
    \307\ See Amendment No. 1 (2021) at 18.
---------------------------------------------------------------------------

    The proposed change related to the 25% TNC/$30MM Threshold is 
appropriate as it provides additional time and flexibility for member 
firms to address operational and related issues related to the 
collection of margin, thereby avoiding unnecessary disruptions to the 
Covered Agency Transaction market. The proposed change related to the 
25% TNC/$30MM Threshold also enhances transparency with respect to the 
scope of transactions which count toward the threshold. This will 
enable broker-dealers to calculate the 25% TNC/$30MM Threshold more 
efficiently, which, in turn, may increase operational efficiencies for 
broker-dealers.
6. Requirement To Enforce Rights To Collect Margin and Liquidate 
Covered Agency Transactions
    A commenter requested clarification with respect to the application 
of the requirement of paragraph (e)(2)(H)(ii)d.3. of FINRA Rule 4210 
under the proposed rule change, which provides that a member whose 
specified net capital deductions exceed the 25% TNC/$30MM Threshold for 
five consecutive business days ``shall also, to the extent of its 
rights, promptly collect margin for each counterparty's excess net mark 
to market loss and promptly liquidate the Covered Agency Transactions 
of any counterparty whose excess net mark to market loss is not 
margined or eliminated within five business days from the date it 
arises, unless FINRA has specifically granted the member additional 
time.'' \308\ More specifically, FINRA stated these requirements apply 
once the member's specified net capital deductions exceed the 25% TNC/
$30MM Threshold for five consecutive business days and cease as soon as 
those capital charges fall below that threshold. Accordingly, FINRA 
stated that once the member's specified net capital deductions fall 
below that 25% TNC/$30MM Threshold (for example, because of market 
movements, or because the member collects enough margin from some, but 
not all, of its counterparties), the member is under no further 
obligation to enforce its contractual rights to collect margin or 
liquidate Covered Agency Transactions (and could, if it chooses, 
rescind outstanding margin calls and halt any liquidations of its 
counterparties' Covered Agency Transactions).\309\
---------------------------------------------------------------------------

    \308\ See SIFMA Letter at 5-6.
    \309\ See Amendment No. 1 (2021) at 19. FINRA also stated that a 
member, so long as it acts promptly to bring itself below the 25% 
TNC/$30MM Threshold, may choose the manner and order in which it 
enforces its rights to collect margin or liquidate Covered Agency 
Transactions, and may halt those actions once its specified net 
capital deductions fall below the 25% TNC/$30MM Threshold. Id.
---------------------------------------------------------------------------

    The Commission finds that FINRA's explanation addresses the 
commenter's request for clarification and enhances transparency with 
respect to the application of 25% TNC/$30MM Threshold. The Commission 
believes that FINRA's explanation also appropriately provides guidance 
with respect to a broker-dealer's ability to rescind outstanding margin 
calls and halt any liquidations of a counterparty's transactions if it 
chooses to do so, once the specified net capital deductions fall below 
the 25% TNC/$30MM Threshold.
7. Reporting by Members With Non-Margin Counterparties
    FINRA stated that, pursuant to paragraph (e)(2)(H)(ii)d.4. of FINRA 
Rule 4210 under the proposed rule change, a member with non-margin 
counterparties would be required to ``submit to FINRA such information 
regarding its unmargined net mark to market losses, non-margin 
counterparties and related capital charges, in such form and manner, as 
FINRA shall prescribe by Regulatory Notice or similar communication.'' 
A commenter indicated that the building of systems and information 
tracking is a significant build for many firms and requested FINRA to 
clarify in advance what information it may require.\310\ In response to 
this comment, FINRA stated that it is considering what information it 
will require broker-dealers to submit and expects to engage members and 
industry participants in developing appropriately tailored reporting 
pursuant to this provision.\311\
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    \310\ See SIFMA Letter at 6.
    \311\ See Amendment No. 1 at 19.
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    FINRA's response to the comment about the reporting by firms with 
non-margin counterparties is appropriate. FINRA is currently 
considering what information it will require and it expects to engage 
with member firms and industry participants in developing tailored 
reporting requirements. This engagement will provide industry

[[Page 50229]]

participants the opportunity to provide input into the reporting 
requirements before FINRA announces them by Regulatory Notice or 
similar communication. The reporting requirements announced in a 
Regulatory Notice or similar communication will provide firms with 
advance notice with respect to what reporting FINRA will require to 
enable them to build out their systems to meet such requirements.
8. Status of Published FAQs
    A commenter asked whether the Covered Agency Transactions FAQs 
\312\ will apply if the Commission approves the proposed rule 
change.\313\ FINRA responded that if the Commission approves the 
proposed rule change, FINRA would update the FAQs with Commission 
staff, members, and industry participants as appropriate.\314\ FINRA's 
response to the comment related to the status of the FAQs appropriately 
confirms that FINRA would re-examine the application of the FAQs, as 
appropriate, if the Commission approves the proposal. With the approval 
of the proposal, FINRA will need to conform the FAQs to the rule, as 
amended by the proposal.
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    \312\ After the original rulemaking was approved, FINRA made 
available a set of FAQs and guidance clarifying certain of the 
requirements, available at: www.finra.org.
    \313\ See SIFMA Letter at 6-7.
    \314\ See Amendment No. 1 (2021) at 20.
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E. FINRA's Proposed Implementation Schedule for the Amended Margin 
Requirements Is Appropriate and Consistent With the Requirements of the 
Exchange Act

1. Comments Received on Proposal
    In response to the proposed rule change, several commenters 
requested that FINRA adopt an implementation period of at least 18 
months after publication of a final rule before compliance is required, 
stating that a constrained time period for implementation could present 
market access risk, and citing the need to build operations and 
technology and to negotiate necessary documentation.\315\ In response 
to Amendment No. 1 (2021), a commenter reiterated its previous comments 
requesting an implementation period of 18 months, or, in the 
alternative, an implementation timeframe of at least one year.\316\
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    \315\ See SIFMA AMG letter at 1-3; SIFMA Letter at 2; BDA Letter 
at 5.
    \316\ See Letter from Chris Killian, Managing Director, 
Securitization, Corporate Credit, Libor, SIFMA (Sept. 10, 2021) at 
1-2. The comment letter was submitted jointly by SIFMA and SIFMA 
AMG.
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    Further, the Petitioners requested that the Commission clarify that 
the proposed rule change would under no circumstances take effect 
earlier than nine to ten months after the full Commission renders its 
final decision.\317\ In requesting this clarification, the Petitioners 
stated that broker-dealers would require the full implementation period 
to bring their policies and procedures, as well as their back office 
systems and information technology infrastructure, into 
compliance.\318\
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    \317\ See Petitioners' Statement at 2-3.
    \318\ See Petitioners' Statement at 2.
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2. FINRA's Response to Comments
    FINRA responded to these comments by stating it believes that the 
subject matter is well understood by member firms and industry 
participants. FINRA stated it would announce the effective date no 
later than 60 days following approval (if the Commission approves the 
proposed rule change) and would provide an effective date between nine 
and ten months following such approval.\319\
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    \319\ See Amendment No. 1 (2021) at 20.
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    FINRA stated that an extended implementation timeframe of 18 months 
would undermine the objectives of the Covered Agency Transaction 
requirements. FINRA also stated that Covered Agency Transactions have 
been under discussion for a considerable time, both prior to and since 
approval of the 2016 Amendments. As a result, FINRA believes that the 
public interest would not be served by continuing to delay effective 
date, and that the timeframe set forth in Amendment No. 1 (2021) is 
appropriate.\320\
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    \320\ See FINRA Letter at 7-8.
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3. Commission Discussion and Findings
    FINRA's proposed implementation schedule is appropriate and 
consistent with the requirements of the Exchange Act. FINRA member 
firms and industry participants are aware of the current requirements 
of the Covered Agency Transaction margin rule and have had time to work 
toward implementation. The proposed rule change eliminates the two 
percent maintenance margin requirements and the need for firms to 
monitor whether a counterparty is an exempt or non-exempt account under 
the rule. The proposed rule change also does not prescribe any new 
margin collection requirements; it is reducing regulatory burdens for 
broker-dealers by providing flexibility to broker-dealers to take a 
capital charge subject to specified terms and conditions in lieu of 
collecting the excess net mark to market loss. The modifications 
provided by the proposed rule change and the timeframe of nine to ten 
months as described in Amendment No. 1 (2021) will provide sufficient 
flexibilities and time for FINRA-member broker-dealers to come into 
compliance with the rule. Finally, in response to commenters requesting 
clarification regarding the implementation timeframe of the proposed 
rule change, the implementation timeframe is measured starting from the 
time of the Commission's approval under this order.

F. Issues Relating to 2016 Amendments

1. This Order Relates Only to the Commission's Review of the Division's 
Approval of the 2021 Amendments by Delegated Authority
a. Comments on the Proposal
    As part of their comments on the proposed rule change, Petitioners 
requested that the Commission repeal the current rule approved by the 
2016 Approval Order, except for the written risk limit determinations 
that are already implemented.\321\ In addition, Petitioners requested 
that the Commission indefinitely delay the effectiveness of the current 
rule under SR-FINRA-2015-036 so that Covered Agency Transaction margin 
collection requirements would not apply to any broker-dealer.\322\
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    \321\ See Petition for Review at 45; SR-FINRA-2015-036 and 2016 
Approval Order.
    \322\ See Petitioners' Statement at 3-4. Petitioners stated that 
because the margin collection requirements set in the current rule 
approved under SR-FINRA-2015-036 have not been implemented and would 
take effect now only if the Commission approved the implementation 
schedule under review in SR-FINRA-2021-010, the Commission could 
prevent both the margin collection requirements under the current 
rule and the proposed rule change from taking effect simply by 
disapproving the proposed rule change. See Petitioners' Statement at 
3, n.4.
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    Several commenters also stated that proposed rule and the 2016 
Amendments are designed for a market that settles on a T+2 basis,\323\ 
and that

[[Page 50230]]

the procedures for clearing and settling mortgage-backed security 
trades are forward looking and involve monthly closing dates that are 
established and proven to function well. These commenters requested 
that the Commission reject the amendments in the proposed rule change 
and instead direct FINRA to revise FINRA-2015-036 to conform with long 
established market practices governing the clearance and settlement of 
Covered Agency Transactions (i.e., repeal the Covered Agency 
Transaction margin requirements).\324\
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    \323\ See definition of Covered Agency Transaction in Exhibit 4 
to Amendment No. 1 (2021). For example, the current rule and 
proposed rule change defines TBA transactions, as transactions 
defined in Rule 6710(u), inclusive ARM transactions, for which the 
difference between the trade date and contractual settlement date is 
greater than one business day. In addition, the proposed rule 
generally requires a broker-dealer to collect margin from a 
counterparty or take a capital charge within if the excess net mark 
to market loss has not been margined or eliminated by the close of 
business on the next business day after the business day on which 
such excess net mark to market loss arises. See paragraph 
(e)(2)(H)(ii)d.1. of Exhibit 4 to Amendment No. 1 (2021). Commenters 
have argued that these definitions and capital charge requirements 
presume a T+2 settlement date. This is not the case as the 
timeframes are solely used to determine which Covered Agency 
Transactions are in scope for purposes of the rule (under both the 
2016 and 2021 Amendments) or when a broker-dealer must begin to take 
capital charges. They are not used to determine clearance or 
settlement dates or standards.
    \324\ See Mesirow Letter at 2; Weichert Letters at 2-3; 
Performance Trust Capital Letter at 2; Loop Capital Letter at 2; 
Siebert Letter at 2; Petitioners' Statement at 3-4; CastleOak 
Securities Letter at 2.
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b. FINRA's Response to Comments
    FINRA stated that Petitioners are using the proposed rule change as 
a vehicle to reopen the current rule under SR-FINRA-2015-036, an 
already concluded rulemaking process in which the Petitioners 
participated, including through the submission of numerous comment 
letters and participation in multiple meetings and telephone calls with 
Commission staff.\325\ FINRA stated that Petitioners' overall issue is 
with the original rulemaking and the idea that FINRA can or should 
require broker-dealers to collect margin on Covered Agency 
Transactions.\326\ FINRA further stated that Petitioners' efforts are, 
at best, untimely, and that Petitioners had an opportunity to request 
Commission and judicial review of SR-FINRA-2015-036 at the appropriate 
time and chose not to do so.\327\ Further, FINRA stated that permitting 
a subsequent review of a previously approved proposed rule change such 
as SR-FINRA-2015-036 would invite serial litigation of SRO rulemaking 
processes, which would disincentivize SROs from proposing and 
implementing improvements to their existing rules through rule changes. 
Finally, FINRA stated it would create significant uncertainty for SRO 
members, their counterparties, and other market participants, who would 
be uncertain as to what SRO rules are final and what approved rules 
could undergo further Commission review.\328\
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    \325\ See FINRA Statement at 21.
    \326\ See FINRA Statement at 12.
    \327\ See FINRA Statement at 12.
    \328\ See FINRA Statement at 12.
---------------------------------------------------------------------------

c. Commission Discussion and Findings
    The 2022 Scheduling Order granted the Petitioner's Petition for 
Review to review the Division staff's approval, pursuant to delegated 
authority, of FINRA's proposed rule change to amend the requirements 
for Covered Agency Transactions under FINRA Rule 4210, that is, the 
2021 Amendments. The 2016 Amendments approved under the 2016 Approval 
Order are not before the Commission today and are outside the scope of 
this order.\329\ If the Commission were to disapprove the proposed rule 
change, as modified by Amendment No. 1 (2021), the margin collection 
requirements under the current rule would be implemented under the 
implementation dates for SR-FINRA-2015-036 that are not a part of this 
proposed rule change.\330\
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    \329\ See File No. SR-FINRA-2015-036.
    \330\ See Exchange Act Release No. 97062 (Mar. 7, 2023), 88 FR 
15473 (Mar. 13, 2023) (File No. SR-FINRA-2023-002) (extending the 
implementation date of the margin collection requirements under SR-
FINRA-2015-036 until October 25, 2023).
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2. The Proposed Rule Change Does not Propose Additional Margin 
Requirements
a. Comments on the Proposal
    Some commenters stated that FINRA and the Commission lack the 
authority to prescribe margin requirements for Covered Agency 
Transactions.\331\
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    \331\ See Brean Capital Letter at 21-23; Melton Letter; BDA and 
Brean Capital Letter at 20-25; Boozman et al Letter at 2; Stephens 
Letter at 2; Petition for Review at 20-26; Petitioners' Statement at 
3.
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b. FINRA's Response to Comments
    FINRA stated that it addressed Petitioners' concern in the original 
rulemaking approved in the 2016 Approval Order, and the Covered Agency 
Transaction margin requirements are consistent with the provisions of 
Section 15A(b)(6) of the Exchange Act.\332\ FINRA also stated that 
Section 7 of the Exchange Act sets forth the parameters of the margin 
setting authority of the Federal Reserve Board and does not bar action 
by FINRA.\333\
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    \332\ See FINRA Letter at 7; FINRA Statement at 13-15.
    \333\ See FINRA Letter at 7; FINRA Statement at 15-21.
---------------------------------------------------------------------------

c. Commission Discussion and Findings
    The current rule requires a FINRA member broker-dealer to collect 
margin from its counterparties with respect to Covered Agency 
Transactions. The 2016 Approval Order previously addressed the question 
of whether FINRA has the authority to prescribe margin requirements for 
FINRA member broker-dealers, stating that it is within FINRA's 
authority to impose margin requirements on its members.\334\
---------------------------------------------------------------------------

    \334\ See 2016 Approval Order, 81 FR at 40374 (``The stated 
goals of the proposal are consistent with the purposes of the 
Exchange Act and with FINRA's authority to impose margin 
requirements on its members.'').
---------------------------------------------------------------------------

    As discussed above, the proposed rule change contains narrow 
amendments to the current rule to reduce regulatory burdens on broker-
dealers through the elimination of the two percent maintenance margin 
requirement for non-exempt accounts, and the addition of the option to 
take a capital charge in lieu of collecting the excess net mark to 
market loss, subject to specified terms and conditions. It does not 
propose any new margin collection requirements. Because the proposed 
rule change for the 2021 Amendments does not propose any new margin 
collection requirements, FINRA's authority to impose such requirements 
is not at issue with respect to the proposed rule change under review.
3. FINRA Previously Addressed Comments Related to the 2016 Amendments
a. Comments Received in Response to Proposal
    In addition to the comments above, the Commission received several 
comments on the proposal that were consistent with comments previously 
received regarding the current rule approved under the 2016 Approval 
Order. Commenters suggested that the counterparty exceptions in the 
rule be expanded to include U.S. Federal Home Loan Banks and mortgage 
originators.\335\ Other commenters suggested that market participants 
should enhance central clearing through MBSD for Specified Pools and 
CMOs and exclude Specified Pools from the scope of the requirements of 
the rule.\336\ Other commenters stated that FINRA should not require 
posting of margin until the next two SIFMA good day settlements.\337\ 
In addition, several commenters stated that sales of new mortgage-
backed securities do not settle on a T+2 basis, and suggested the 
trades at issue should be marginable only if they settle outside of the 
SIFMA good-day settlement schedule.\338\
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    \335\ See SIFMA Letter at 6; MBA Letter at 2-3.
    \336\ See Brean Capital Letter at 23-25; Melton Letter.
    \337\ See Brean Capital Letter at 25. Generally, a TBA trade is 
a transaction where the securities to be delivered are agreed upon 
on the trade date and are delivered in the future according to a 
monthly settlement schedule established by SIFMA, through 
consultation with its members. These settlement dates are generally 
referred to as ``good day'' settlement dates.
    \338\ See BDA Letter at 2; Weichert Letters at 2; Stephens 
Letter at 3-4; Duncan-Williams/SouthState Bank Letter at 2, 4; BDA 
Small Firms Letter at 2, 3.

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[[Page 50231]]

b. FINRA's Responses to Comments
    As discussed in section III.A.2.b. above, in response to the 
comments to the Notice, FINRA stated that it has engaged with industry 
participants extensively on their concerns, and has addressed them on 
multiple occasions since the process of soliciting comment on 
requirements for Covered Agency Transactions began in January 2014 with 
the publication of Regulatory Notice 14-02 and in 2015 with FINRA's 
original rulemaking for Covered Agency Transactions.\339\ FINRA also 
stated that the original rulemaking is necessary because of the risks 
posed by unsecured credit exposures in the Covered Agency Transactions 
market.\340\
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    \339\ See Amendment No. 1 (2021) at 4.
    \340\ See Amendment No. 1 (2021) at 4-5; 2015 Notice, 80 FR at 
63615-16.
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    FINRA also stated that it has addressed, on multiple occasions, the 
need to include Specified Pool Transactions and CMOs within the scope 
of the requirements,\341\ and made key revisions in finalizing the 
original rulemaking expressly to mitigate any potential impact on 
smaller firms and on activity in the Covered Agency Transaction market, 
including increasing the small cash counterparty exception from $2.5 
million to $10 million, subject to specified conditions, and modifying 
the two percent maintenance margin requirement, as adopted pursuant to 
the original rulemaking, to create an exception for cash investors that 
otherwise would have been subject to the requirement.\342\
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    \341\ See Amendment No. 1 (2021) at 5; 2016 Approval Order, 81 
FR at 40371.
    \342\ See Amendment No. 1 (2021) at 5; 2015 Notice, 80 FR at 
63608.
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    FINRA also stated that it exempted mortgage bankers from the 
maintenance margin requirements in the original rulemaking; exempted 
multifamily housing securities and project loan program securities from 
the new margin requirements; \343\ and established a $250,000 de 
minimis transfer amount, for a single counterparty, subject to 
specified conditions, up to which members need not collect margin or 
take a charge to their net capital.\344\ Finally, FINRA responded that 
it does not propose to make the suggested modification to exclude the 
U.S. Federal Home Loan Banks from the scope of the rule because it 
would undermine the rule's purpose of reducing risk.\345\
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    \343\ See Amendment No. 1 (2021) at 6; Partial Amendment No. 1 
to SR-FINRA-2015-036, available at https://www.finra.org/rules-guidance/rule-filings/sr-finra-2015-036.
    \344\ See Amendment No. 1 (2021) at 17; 2016 Approval Order, 81 
FR at 40368.
    \345\ See Amendment No. 1 (2021) at 17.
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c. Commission Discussion and Findings
    The Commission agrees with FINRA that some comments have been 
previously addressed in the original rulemaking, including whether to: 
(1) exclude additional products or counterparties from the scope of the 
rule, such as Specified Pools and CMOs; or (2) adjust the requirement 
to collect margin based on SIFMA's good day settlements.\346\ 
Nevertheless, while the Commission agrees that these comments have been 
addressed previously, to the extent that they relate to the proposed 
rule changes set forth in the 2021 Amendments, and not solely to the 
2016 Amendments, by suggesting alternative approaches to the 2021 
Amendments that should be considered, the Commission disagrees with 
commenters' recommendations. Specifically, the Commission believes that 
excluding additional products or counterparties would undermine the 
purpose of the rule to address the risk of unsecured credit from 
Covered Agency Transaction for broker-dealers and encourage the 
collection of margin. In addition, excluding additional products from 
the scope of the rule would result in a mismatch between FINRA margin 
requirements and TMPG best practices of exchanging variation margin for 
Covered Agency Transactions which may potentially distort trading in 
the Covered Agency Transaction market by incentivizing counterparties 
to trade in non-margined products.
---------------------------------------------------------------------------

    \346\ See, e.g., 2016 Approval Order, 81 FR at 40375-76 
(``[E]xcluding additional products from the rule or modifying the 
settlement dates in the definition of Covered Agency Transactions 
potentially may ``undermine the effectiveness of the proposal'' if 
counterparties are permitted to maintain unsecured credit exposures 
on these positions.'').
---------------------------------------------------------------------------

    Moreover, the option to take a capital charge in lieu of collecting 
margin for the excess net mark to market loss will provide broker-
dealers with the flexibility to choose not to collect margin from 
specific counterparties or for specific transactions, while continuing 
to protect broker-dealers from the risk of unsecured credit exposures 
arising from Covered Agency Transactions. In addition, adjusting the 
time to collect margin or take capital charges related to SIFMA good 
settlement dates or other longer time periods also would undermine the 
effectiveness of the rule because these suggested changes would have 
the effect of generally requiring no margin or minimal capital charges 
(that is, they would have the effect of essentially reverting back to 
current and inconsistent margin practices among FINRA broker-dealers).
    Finally, proposals to expand clearing for Covered Agency 
Transactions through MBSD is outside the scope of this proposed rule 
change.

IV. Conclusion

    For the foregoing reasons, the Commission finds that the proposed 
rule change, as modified by Amendment No. 1 (2021), is consistent with 
the Act and the rules and regulations thereunder applicable to a 
national securities association.
    It is Therefore Ordered, pursuant to Rule 431 of the Commission's 
Rules of Practice, that the earlier action taken by delegated 
authority, Exchange Act Release No. 94013 (Jan. 20, 2022), 87 FR 4076 
(Jan. 26, 2022), is set aside and, pursuant to Section 19(b)(2) of the 
Act,\347\ the proposed rule change (SR-FINRA-2021-010), as modified by 
Amendment No. 1 (2021), hereby is approved.
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    \347\ 15 U.S.C. 78s(b)(2).

    By the Commission.
J. Matthew DeLesDernier,
Deputy Secretary.
[FR Doc. 2023-16267 Filed 7-31-23; 8:45 am]
BILLING CODE 8011-01-P


